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43–896 PDF 2008

S. HRG. 110–459 

NON-COMMERCIAL INSTITUTIONAL INVESTORS ON 

THE PRICE OF OIL 

HEARING 

BEFORE THE

COMMITTEE ON 

ENERGY AND NATURAL RESOURCES 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

TO

EXAMINE THE INFLUENCE OF NON-COMMERCIAL INSTITUTIONAL 

INVESTORS ON THE PRICE OF OIL 

APRIL 3, 2008 

( 

Printed for the use of the 

Committee on Energy and Natural Resources 

(II) 

COMMITTEE ON ENERGY AND NATURAL RESOURCES 

JEFF BINGAMAN, New Mexico, Chairman 

DANIEL K. AKAKA, Hawaii 

BYRON L. DORGAN, North Dakota 

RON WYDEN, Oregon 

TIM JOHNSON, South Dakota 

MARY L. LANDRIEU, Louisiana 

MARIA CANTWELL, Washington 

KEN SALAZAR, Colorado 

ROBERT MENENDEZ, New Jersey 

BLANCHE L. LINCOLN, Arkansas 

BERNARD SANDERS, Vermont 

JON TESTER, Montana 

PETE V. DOMENICI, New Mexico 

LARRY E. CRAIG, Idaho 

LISA MURKOWSKI, Alaska 

RICHARD BURR, North Carolina 

JIM DEMINT, South Carolina 

BOB CORKER, Tennessee 

JOHN BARRASSO, Wyoming 

JEFF SESSIONS, Alabama 

GORDON H. SMITH, Oregon 

JIM BUNNING, Kentucky 

MEL MARTINEZ, Florida 

ROBERT M. SIMON, Staff Director 

SAM E. FOWLER, Chief Counsel 

FRANK MACCHIAROLA, Republican Staff Director 

JUDITH K. PENSABENE, Republican Chief Counsel 

(III) 

C O N T E N T S 

STATEMENTS 

Page 

Barrasso, Hon. John, U.S. Senator From Wyoming ............................................. 6 

Bingaman, Hon. Jeff, U.S. Senator From New Mexico ........................................ 1 

Book, Kevin, Senior Analyst and Senior Vice President, FBR Capital Markets 

Corporation, Arlington, VA ................................................................................. 25 

Burkhard, James, Managing Director, Cambridge Energy Research Associates, Cambridge, MA ........................................................................................... 33 

Cino, Victor J., President, Pyramid Oil Marketing ............................................... 72 

Cota, Sean, Co-Owner and President, Cota & Cota, Inc., President, New 

England Fuel Institute, Bellows Falls, VT ........................................................ 37 

Domenici, Hon. Pete V., U.S. Senator From New Mexico .................................... 3 

Dorgan, Hon. Byron, U.S. Senator From North Dakota ...................................... 5 

Eichberger, John, Vice President, Government Relations, National Association 

of Convenience Stores, Alexandria, VA .............................................................. 43 

Emerson, Sarah A., Managing Director, Energy Security Analysis, Inc., Wakefield, MA ............................................................................................................... 18 

Harris, Jeffrey, Chief Economist, Commodity Futures Trading Commission .... 7 

Salazar, Hon. Ken, U.S. Senator From Colorado .................................................. 2 

APPENDIX 

Responses to additional questions .......................................................................... 77 

(1) 

NON-COMMERCIAL INSTITUTIONAL 

INVESTORS ON THE PRICE OF OIL 

THURSDAY, APRIL 3, 2008 

U.S. SENATE, COMMITTEE ON ENERGY AND NATURAL RESOURCES, Washington, DC. 

The committee met, pursuant to notice, at 9:35 a.m. in room SD– 

366, Dirksen Senate Office Building, Hon. Jeff Bingaman, chairman, presiding. 

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. 

SENATOR FROM NEW MEXICO 

The CHAIRMAN. Ok. Why don’t we get started here? I think there 

will undoubtedly be things that try to interrupt us as we go forward. I thank the witnesses for joining us. 

Today’s hearing will be about an issue that we’ve been debating 

in Congress for a number of years. That is how increased speculation in financial energy markets is contributing to recent record 

setting oil prices. Certainly there’s a broad recognition that the 

fundamentals of supply and demand explain much of the current 

oil price. 

We see increased oil demand especially in developing economies 

such as China and India. We’ve seen OPEC oil production policies 

successfully manage U.S. and global oil inventory levels keeping 

global commercial stocks low. This adds to market tightness and 

upward price pressure. At the same time we see frequent small 

scale oil supply interruptions, which in the last week included sabotage of energy infrastructure in Iraq, Ecuador, Nigeria, which are 

all OPEC members. 

We also have a misguided, in my view, policy with regard to continued filling of the Strategic Petroleum Reserve. Senator Dorgan 

has consistently pointed out this and has been trying to do something about it, which I support. This removes more oil from the 

marketplace than the small-scale disruptions. Clearly there are 

fundamental factors that are very important, but as we heard from 

Guy Caruso, the Administrator of EIA, these market fundamentals 

could explain perhaps as much as $90 of the current price of a barrel of oil. 

In addition to these factors there have been a number of important developments in financial markets in recent years. These 

trends include a dramatic increase in the volume of trading in oil 

derivative markets, the participation of new classes of traders in 

those markets. These trends are exacerbated by the historic weakVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
2 

ness of the dollar, which encourages non-commercial investors to 

seek commodity investments in order to protect against inflation 

risk. 

According to a GAO report issued last fall, the average standing 

contract volume for crude oil traded on the New York Mercantile 

Exchange increased by 90 percent between 2001 and 2006. In addition, GAO noted the average daily number of non-commercial participants in crude oil markets included hedge funds and large institutional investors more than doubled from 2003 to 2006. So taken 

together, it seems that just as the demand for physical barrels of 

oil has grown with the global economy there is also an increased 

demand for oil purely as a financial asset. 

Untangling whether and how these dual sources of demand may 

be operating in concert and potentially impacting all prices is complicated. Certainly, I think, it’s accurate to say there’s growing suspicion on the part of many Americans that at the very least Wall 

Street’s geo-political judgments may be serving to increase current 

pricing trends. To my mind, unraveling these issues is made more 

difficult to the extent that we’re confronted with the lack of reliable 

and comprehensive data across these markets. 

There’s a notable lack of reliable information with respect to 

global oil reserves; a lack of transparency related to certain corners 

of financial markets. It seems to me that markets operate best on 

the basis of complete and reliable information. In the absence of 

such information the probability increases for prevailing market 

prices to become untethered from the fundamental supply and demand consideration. In addition, I think it’s also important for us 

to better understand the degree to which energy commodities in a 

purely financial sense have become an attractive investment given 

the state of the overall U.S. economy. 

Today we have a very distinguished panel of witnesses, and I 

look forward to hearing from each of them on these complicated 

issues. I thank them for being here. 

Let me defer to Senator Domenici for any opening statement he’d 

like to make. 

[The prepared statement of Senator Salazar follows:] 

PREPARED STATEMENT OF HON. KEN SALAZAR, U.S. SENATOR

FROM COLORADO

Thank you Chairman Bingaman and Ranking Member Domenici for holding today’s hearing on the influence of speculators and non-commercial investors on the 

price of oil. Today’s hearing should shed light on the economic and market forces 

that determine the price of oil. Global demand for this resource grows stronger 

daily. This demand now comes in two varieties: demand for the physical product 

itself, and demand for oil as an investment commodity—so-called ‘‘paper barrels.’’ 

In an increasingly uncertain global financial climate, many investors are seeking to 

lock their capital into commodities. At the same time, consumers and businesses are 

powerless as gasoline prices skyrocket. 

We are all aware that the price of oil hit an all-time inflation-adjusted high last month. Some are projecting that we’ll have $4 per gallon gasoline this summer. 

Many analysts have suggested that speculation in the crude oil market has played 

a determining role in the price surge. The recent increase in trading volume on energy commodities markets highlights the rising significance of investors’ and speculators’ behavior. It is reasonable to suspect that this behavior plays a significant role 

in determining the price of oil, and therefore the price of gasoline. If this is in fact 

the case, consumers are paying the price for investors’ priorities. 

Many people are also worried that the crude oil derivatives markets are susceptible to manipulation. We know from the Enron scandal that without adequate overVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00006 Fmt 6633 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
3 

sight and regulation, market manipulation is possible—and that the consequences 

can extend far beyond the bottom-lines of the investors involved and their shareholders to affect the lives of individual consumers. The new Energy Independence 

and Security Act explicitly prohibits manipulation of crude oil, gasoline and petroleum distillates wholesale markets. I am particularly interested to hear our panelists’ assessments of whether the regulatory structures exist to properly enforce this 

new statute. 

In the bigger picture, oil prices are still largely a function of OPEC’s supply-and 

price-setting whims. The U.S. consumes 25 percent of the world’s oil, but produces 

only 3 percent. Given our limited domestic supplies of crude oil, it is wrong to suggest that drilling in the Arctic or even offshore would have any impact on world 

prices. At the end of the day, we are still captive to OPEC’s preferred oil price. 

Ensuring a rational and open crude oil market is a matter of national and economic security. Because of strong leadership from this Congress, our country is on 

the verge of a clean energy revolution that will reduce our oil consumption. However, as we continue to rely on foreign oil in our transportation sector, it is imperative for us to understand the forces that affect the oil market. We must do everything we can to shield consumers from oil price shocks. I look forward to discussing 

these issues with our witnesses today, and I thank them each for participating. 

Thank you, Mr. Chairman. 

STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM 

NEW MEXICO 

Senator DOMENICI. Thank you very much, Mr. Chairman. 

Thanks to all of you for coming. 

Mr. Chairman I might say that I listened carefully to your statement. Rather than deliver a detailed statement I would say for the 

record that I agree with everything Senator Bingaman said except 

two things that we already know we disagree on. One is SPR. I 

think it has an impact but I think the risk we’re up against instead 

of having an extreme shortage justifies us having SPR and even 

perhaps even having it bigger than it is. 

Other than that I agree with his comments and observations. I’m 

very concerned about whether we can ever find out the facts. But 

I hope that today we at least begin to understand the extent to 

which oil is becoming a commodity, in that it is being used to a 

much larger extent in the market for oil and what is the impact 

of that. 

Now I think we know a few answers there. Commodity trading 

is growing dramatically: the part that is observed and readily seen 

is growing dramatically, and so is the over-the-counter market. 

All that means, in my opinion, is that rather than buying the 

commodity, oil permits itself to be traded by all kinds of instruments that can be invented and used by those who trade for commodities. That oil comes closer and closer to being a commodity 

rather than being a good that is sold and bought on the market. 

I concur with the Senator, the chairman, that there are various 

reasons that stand right out and indicate why the price is going up 

so much. It is obvious that the demand for oil is incredible. As compared with 10 years ago, the new users in the market including 

China and India are having an absolutely dramatic effect. 

In addition the United States, with everything we do, is still unable to reduce its importation. We are using less, but at the same 

time our own production is going down. As a result, we are importing more. 

We are net importers. So we belong in that same category with 

China. We have a dramatic impact on the world market. Much of 

our capital goes into $100 a barrel oil, even with our dollar devaluVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00007 Fmt 6633 Sfmt 6602 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
4 

ing which the chairman spoke of. All of those are real impact of our 

current. 

But some people say it is the speculators using these various 

commodity instruments, that are influencing high oil prices. Some 

say their actions add 10Rrcent impact, some say 50 percent. I think 

we did right on this committee to try and find out, as best we can, 

what that percentage is. But I’m not sure we’re going to find out. 

We’re going to hear opinions. But again, I’m not sure we’re going 

to find an exact answer. Instead, I think sooner or later we will get 

to the point of knowing enough to see if we have to change the way 

things are done or not. 

Right now I wouldn’t know how to change it without having people claim we’re taking a risk that we shouldn’t take, because we 

don’t know enough. But I’m not averse to letting it be known that 

this Senate committee is serious about looking at the commodity 

trading of crude oil because we are concerned about whether or not 

that’s having an unreasonable impact, a speculative impact, on the 

price of oil. 

Thank you to the witnesses. I wish to hear from you. Thank you, 

Mr. Chairman. 

[The prepared statement of Senator Domenici follows:] 

PREPARED STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM

NEW MEXICO

Welcome. I want to thank our panel of witnesses for taking time out of their busy 

schedules to join us today. Your testimony will be invaluable as we look into the 

role of non-commercial investors in the crude oil market. 

In previous hearings, and discussions with others, we’ve heard everything from 

‘‘speculators have little or no independent impact on the price of oil’’ to ‘‘they’ve driven up the price an additional $50 dollars or more.’’ I commend the chairman for convening this hearing to attempt to shed more light on the true impact of these markets. 

This is a useful discussion, and we must pay close attention to energy trading because of it clearly is a significant component of our energy markets. I am very concerned that it will deflect us focus from the factors that we KNOW threaten our 

energy security. I’m afraid that some may find that it is easier to blame nameless 

‘‘oil speculators’’ for all our troubles rather than face the reality of fundamental 

problems with how we produce and consume energy in the United States and the 

world. 

What are the factors that we know are driving up oil prices? First, higher demand. Despite a dramatic 60% increase in oil prices over the last year, the Energy 

Information Administration (EIA) projects that world oil consumption will continue 

to increase this year. This strong increase in demand, despite rising prices, is the 

result of economic growth in China, and India. Even despite a slower economy, consumption in the U.S. is expected to grow, as well. 

In addition to an increase in global oil demand and a reduction in supply, geopolitical instability in Nigeria, Iraq, Iran, and Venezuela, and the weakening of the 

dollar have driven oil prices higher. 

How has the depreciation of the dollar affected crude oil prices? Most oil price contracts are denominated in dollars and since 2002 the dollar has decreased in value 

by 30% against major currencies. This means that American consumers are more 

affected by the price of crude oil then consumers from other countries who have a 

stronger currency, such as the Euro or the Yen, because the prices of imports have 

gone up. 

With high prices and growing consumption worldwide, we must find ways to increase domestic supplies. U.S. crude oil production is projected to decline 10,000 

barrels a day in 2008. This, combined with projected increases in U.S. petroleum 

consumption, will require this country to rely even more heavily on foreign oil imports and continue to ship nearly $400 billion annually overseas to import oil. 

Mr. Chairmen, I appreciate your willingness to examine the role of non-commercial investors in the crude oil market. But we must also recognize that while nonVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00008 Fmt 6633 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
5 

commercial investors may contribute something to high oil prices, it is just one piece 

of a very large puzzle. I look forward to hearing from today’s witnesses, and, going 

forward, to working with the members of this Committee to resolve all of the major 

obstacles to our Nation’s energy security. 

The CHAIRMAN. Thank you. Senator Dorgan wanted to make a 

statement here. Let me call on him. 

STATEMENT OF HON. BYRON DORGAN, U.S. SENATOR FROM 

NORTH DAKOTA 

Senator DORGAN. Chairman, thank you. I wanted to make a comment. I had requested, among others, that this hearing be held. I 

think this is very important. 

The last 24, 36 hours, 2 airlines have shut down. We see news 

reports about truckers deciding that they can’t continue trucking. 

They’re going to slow down. They can’t afford to buy the fuel. These 

energy prices are having significant consequences. 

I’m not very generous with respect to the notion that it’s just 

supply and demand that is driving these energy prices. I don’t 

think pure supply and demand describes why the price of oil has 

gone from $50 to $100 in a relatively short period of time. I think 

the evidence is pretty substantial. 

There’s an orgy of speculation in the futures market. We’ve got 

people buying what they’ll never get from people who never had it. 

I understand these markets and the reason for the markets and 

the need for liquidity in markets. But I think there has been an 

unbelievable amount of speculation. 

We’ve not sat in this room before when hedge funds were neck 

deep in the oil and commodities futures markets. We’ve not sat in 

these rooms before when investment banks were actually buying oil 

storage so they could speculate and actually take oil off the market 

and put it in storage away before the price of oil goes up. There’s 

an unbelievable amount of speculation, in my judgment. 

Twenty times more oil is sold every single day in these markets 

than exists. Think of that. Now we’ve had testimony before this 

committee, Mr. Chairman, by some pretty respected analysts, top 

analysts for Oppenheimer and Company says there’s no justification for the price of oil to be where it is. 

It’s about $20 to $30 above where it ought to be because this is 

a 24/7 casino with unbelievable speculation. I believe it’s our job, 

and not to simply say well it’s supply and demand. It’s our job to 

ask tough questions. 

We have a margin requirement here of what, 5 to 7 percent. You 

can control $100,000 worth of oil with a $5,000 or $7,000 investment. You can’t do that on the stock market. We ought to increase 

the margin requirements in this country and get the speculators 

out of this system. 

So, I feel very strongly about this. The consequences of what’s 

happening with the price of oil are all around us. I understand the 

Indians are going to drive more cars. I understand the Chinese are 

going to drive more cars. I understand the future fundamental 

issues. I don’t understand the current price, relative to the fundamentals, that exist today in these markets. I think there’s an 

orgy of speculation that we ought to be deciding to do something 

about. 

6 

The CHAIRMAN. Let me ask if any other Senator wishes to make 

a statement. 

Senator Barrasso. 

STATEMENT OF HON. JOHN BARRASSO, U.S. SENATOR 

FROM WYOMING 

Senator BARRASSO. Yes. Mr. Chairman, thank you very much. 

Mr. Chairman, the message that I heard loud and clear during 

the most recent recess was that record prices at the pump are hurting the wallets of Wyoming families and American families. High 

oil prices hit consumers in States like Wyoming particularly hard, 

but it’s just not Wyoming. It’s Colorado. It’s North Dakota. It’s New 

Mexico. This committee is well represented with folks who are from 

States where people travel long distances to go to work, to run errands, and to see friends and family. 

Mr. Chairman, I understand that the Research Director with 

Greenpeace was quoted earlier this week as saying that his organization wasn’t inherently against high gas prices. I want to be very 

clear, Mr. Chairman, I’m very concerned about the prices at the 

pump. I’m pleased that this committee is holding this hearing. 

There are multiple contributors to today’s price of oil. Some relate to the fundamentals of demand and supply and growing world 

economies. Others relate to the geopolitical tensions, the weakness 

in the dollar, environmental regulations and the like. But in markets with very little available excess supply, marginal contributions 

to supply and demand seem particularly influential. 

I don’t believe that the American oil producers and refiners and 

distributors or the corner service stations are solely responsible for 

today’s high gasoline prices. In that context the world economy, 

America’s producers are generally price takers, not price makers. 

Free markets and competition serve to keep prices in check, but at 

a minimum I strongly believe government policies should not drive 

oil prices higher. This is true when it comes, in my mind, to deposits into the Strategic Petroleum Reserve, any calls for higher taxes 

at the pump or government mandates. 

There are some short and long term policy proposals, which I believe warrant congressional attention. I am compelled by the GAO’s 

recommendations that we begin dollar cost averaging in purchasing 

heavy oil for the Strategic Petroleum Reserve. These steps are simply sound, financially responsible measures. 

I think Senator Dorgan’s call for a temporary suspension of deposits into the Strategic Petroleum Reserve until the price is below 

a certain level have merit and should be debated. I believe high 

prices at the pump will ultimately encourage consumers to seek out 

individual ways to conserve and to invest in more efficient transportation. But these responses may not provide the immediate relief that the consumers need. 

Congress has more tools that can and should be on the table. 

Part of a comprehensive solution must incorporate a vision for the 

future and expanded domestic production. There are areas throughout America that have vast potential for oil development and serious consideration must be given in how we manage these lands and 

deep seas. 

7 

Another component is technology. America must capitalize on existing opportunities and continue to invest in emerging energy 

technologies. One technology to me that is especially interesting is 

in the terms of domestic transportation fuel: coal to liquids. With 

respect to market excessive speculation, Congress needs to explore 

the extent to which price manipulation is occurring and to what extent the impacts can be minimized. 

I appreciate the chairman’s efforts in calling this hearing. In this 

global economy will more regulation result in America losing its 

leadership in financial markets? Or can stepped up efforts, to root 

out excessive speculation and manipulation, ultimately help American consumers? 

I’m also increasingly compelled by concerns over our trade deficit. As America expends more and more of our hard earned money 

to purchase foreign oil of particular interest to the activities of the 

sovereign wealth funds. These funds, often supported national oil 

profits, can serve as a self-reinforcing mechanism pushing oil future prices up higher than they otherwise would have been. 

So with that, Mr. Chairman, I look forward to today’s informative discussion. Thank you for holding these hearings. 

The CHAIRMAN. Thank you very much. Unless other members 

have just some burning need to speak at this point, I would prefer 

to go ahead and hear from our witnesses. Why don’t we do that? 

Let me introduce the six distinguished witnesses we have, and 

just have them testify in this order if they would. Jeffrey Harris 

is here from the Commodity Futures Trading Commission. Thank 

you for being here. 

Sarah Emerson from Energy Security Analysis. Thank you for 

being here. 

Kevin Book is here with Friedman Billings Ramsey and Company in Arlington, Virginia. 

Jim Burkhard is here from Cambridge Energy Research Associates. Thank you for being here. 

Sean Cota is here representing the Petroleum Marketers Association of America. 

John Eichberger is here representing the National Association of 

Convenience Stores. 

So thank you all for being here. If each of you could take about 

6 minutes or something like that and make the main points that 

you think we need to understand from your testimony. We will include your entire testimony in the hearing transcript. 

Mr. Harris. 

STATEMENT OF JEFFREY HARRIS, CHIEF ECONOMIST, 

COMMODITY FUTURES TRADING COMMISSION 

Mr. HARRIS. Thank you, Mr. Chairman and members of the committee. I am Jeffrey Harris, Chief Economist of the Commodity Futures Trading Commission or the CFTC. I appreciate the opportunity to discuss the CFTC’s role with respect to crude oil futures 

markets and the Office of Chief Economist’s view of current trends 

in the marketplace as part of the government regulator charged 

with overseeing them. 

Congress created the CFTC in 1974 as an independent agency 

with a mandate to regulate commodity futures markets in the 

8 

* Figures have been retained in committee files. 

United States. Broadly stated CFTC’s mission is two-fold. To protect the public and market users from manipulation, fraud and 

abusive practices and to assure that open, competitive and financially sound markets for commodity futures and options. 

Commodity commission’s oversight of future trading is focused on 

the New York Mercantile Exchange, West Texas intermediate 

crude oil contract. That’s it. Designated contract market. Secondarily on the intercontinental exchanges in Europe, ICE futures of 

Europe contract because one of its contracts cash settles on the 

NYMEX settlement price. 

The CFTC receives millions of data points everyday about trading activity in our markets. The agency’s large trader data base 

system is the cornerstone of our surveillance system and is used to 

analyze data. Large trader positions reported to CFTC consistently 

represent more than 90 percent of all trading interest in NYMEX’s 

WTI contract with the remainder being allocated to small traders 

who don’t meet reporting requirements. 

The CFTC closely tracks the developments in the crude oil markets. Crude oil prices have risen significantly in the last few years. 

Are currently above $100 a barrel. Concurrently open interest in 

WTI contracts has expanded dramatically from about one million 

contracts in 2004 to more than 2.8 million contracts in the most recent week. 

The Office of the Chief Economist has studied these markets to 

better understand the compliments of this rapid growth. Our studies find three major things. 

First, we find similar rates of growth for both commercial and 

non-commercial trading interest. Where non-commercial interest is 

commonly considered speculative. 

Second, most of the growth in trading interest is concentrated in 

futures contracts that expire after 12 months suggesting that an 

increase in ability for hedging at longer horizons now exists in our 

markets. 

Figures 1–A and 1–B* in my presentation here demonstrate 

these two points. 

The CHAIRMAN. Are these also in the testimony? 

Mr. HARRIS. These are also in the written testimony, yes. 

The CHAIRMAN. Ok. 

Mr. HARRIS. We’ve highlighted here 2000 verses 2007. As you 

can see the 2007 bars are much larger for commercial traders in 

2007 than they were in 2000. Figure 1–B highlights the positions 

of non-commercial traders or speculators in these markets, which 

also exhibit significantly larger trading volume. 

The second component is that you can see the bars are much 

larger as we move to the right on these graphs indicating the 

greater propensity or the opportunity to hedge in the futures markets at longer horizons. 

Figures 1–A and 1–B also highlight the fact that commercial 

trading in short positions, hedging in the market, rely intimately 

on the ability of the speculators to take the opposite sides of trades. 

The CHAIRMAN. Let me just ask on this. The second, the columns 

there, do I understand it correctly that that indicates the—— 

9 

Mr. HARRIS. The bars above the zero mark are long positions. 

The CHAIRMAN. Right. So there’s—— 

Mr. HARRIS. Bars below are short. 

The CHAIRMAN. So there’s been well over a tenfold increase in 

the number of non-commercial traders involved in these 3 to 6 

month futures contracts. Is that accurate? 

Mr. HARRIS. Yes. 

The CHAIRMAN. Ok. Go right ahead. 

Mr. HARRIS. The point being with commercial traders being short 

and non-commercials being long, the supply and demand for hedging services intimately ties hedgers and speculators together in futures markets. 

The third major trend during the past few years is that crude oil 

markets have witnessed a rapid growth in swap dealer trading. 

Swap dealers now hold significantly larger positions in crude oil. 

These dealers, who take the short sides of over the counter swap 

trades lay off their risk with long positions in the crude oil futures 

markets. 

This development has altered the traditional role of commercial 

traders. Previously commercial traders predominately hedged using 

long positions in the stock market and went short in the crude oil 

futures markets. Recent development has swap dealers, those also 

classified as commercial dealers, hedging their short, swap positions with long positions in our futures markets. 

Figures 2–A here and 2–B show the difference between the two 

different types of commercial traders. 2–A shows that traditional 

commercial traders are typically net short in the near term futures 

contract. Swap dealers also considered commercial traders are net 

long in these same contracts. So commercial traders, depending on 

the type, trade very differently in our markets. 

Figure 2–B also demonstrates the growth in swap dealer market 

in the near term futures contracts. Partially represents this flow 

from commodity index trading. Even the substantial increase in 

open interest in crude oil futures, the Office of the Chief Economist 

utilizes the Commission’s extensive data to examine the role of all 

market participants. How their positions might affect prices. 

Although longer term studies show a slight increase in the number of non-commercial market share in crude oil market, OCE analysis shows that more recent increases in oil prices to levels above 

$100 has not been accompanied by significant changes to participants in the market. Figure 3 here shows that the number of commercial and non-commercial traders has remained nearly constant 

over the last 22 months with about 120 commercial and 310 noncommercial traders in the market. 

OCE has also studied the impact of speculators as a group in the 

oil markets during the most recent price run up. Specifically we 

have closely examined the relationship between futures prices and 

the positions of speculators in the crude oil markets. Our studies 

have consistently found that when new information comes to the 

market it is commercial traders such as oil companies, utilities and 

airlines who react first by adjusting their futures positions. When 

these commercial traders adjust their futures positions it is speculators who are most often taking the other side of their trade. 

10 

Price changes that prompt hedgers to alter their futures positions attract speculators who’ve changed their positions in response. Simply stated there is little evidence that position changes 

by speculators precede price changes in the crude oil futures contracts. Instead, changes in commercial traders significantly precede 

oil price changes. 

To highlight this effect a bit more clearly, Figure 4 plots the 

prices in the market share one group of highly active speculators, 

managed money traders, over the past 22 months. Notably, while 

the WTI contract prices have doubled in the last 14 months managed money positions, as a fraction of their overall market have 

changed very little. Speculative positions do not generally amplify 

crude oil price changes. 

More specifically, the recent crude oil price increases have occurred with no significant change in the net speculative positions. 

The OCE has also studied position changes of commercial and noncommercial traders by category finding similar results. We find little evidence that net positions changes of any category of non- commercial traders is affecting or preceding price changes in crude oil 

futures prices. 

Figure 5 highlights the fact that commercial and non-commercial 

open interest has grown during the most recent 22 months. But 

generally this growth remains balanced between long and short positions for each trader group. Looking at the trends in the marketplace combined with studies on the impact of speculators in the 

market there is little evidence that changes the speculative positions are systematically driving up crude oil prices. 

Given the relatively stable make up of participants and their positions in the markets and the absence of evidence of speculation 

causing oil price changes, it appears that fundamentals provide the 

best explanation for crude oil price increases. These fundamentals 

can be either broad factors affecting many markets like the dollar 

or general inflation fears or factors particular to this market such 

as strong demand from China or India. In addition geopolitical 

events, tensions in Venezuela, Nigeria and other countries have affected crude oil markets. 

Concerns about the high price of oil are not unique to the United 

States. I recently presented some of these findings to the International Energy Agency in Paris, which representatives attended 

from 40 different countries, OPEC, industry economists and traders. Our findings were supported by many of the conference presenters and attendees who’ve conducted their own research on 

these topics. 

Given the widespread interest in crude oil in particular, is something I’m certain we will continue to monitor closely as will my 

counterparts around the world. This concludes my remarks. I’d be 

happy to answer any questions if you’d like. 

[The prepared statement of Mr. Harris follows:] 

PREPARED STATEMENT OF JEFFREY HARRIS, CHIEF ECONOMIST, COMMODITY FUTURES

TRADING COMMISSION

Thank you, Mr. Chairman and members of the Committee. I am Jeffrey Harris, 

Chief Economist of the Commodity Futures Trading Commission (CFTC or Commission). I appreciate the opportunity to discuss the CFTC’s role with respect to the 

11 

crude oil futures markets and our view of current trends in the markets as the government regulator charged with overseeing them. 

CFTC MISSION

Congress created the CFTC in 1974 as an independent agency with the mandate 

to regulate commodity futures and option markets in the United States. Broadly 

stated, the CFTC’s mission is two-fold: to protect the public and market users from 

manipulation, fraud, and abusive practices; and to ensure open, competitive and financially sound markets for commodity futures and options. To do this, the Commission employs a highly-skilled staff who work to oversee the markets and address 

any suspicious or illegal market activity. 

The Commodity Exchange Act (CEA or Act) grants the Commission exclusive jurisdiction with respect to, among other things, accounts, agreements, and transactions involving commodity futures and options contracts that are required to be 

traded or executed on an exchange or a designated contract market, also known as 

a DCM. DCMs are regulated futures exchanges that are self-regulatory organizations (SROs) subject to comprehensive oversight by the CFTC. DCMs can list for 

trading any type of contract, they can permit intermediation, and all types of traders (including retail traders) are permitted to participate in their markets. 

The CFTC has been overseeing the U.S. futures industry under principles-based 

regulation since the passage of the Commodity Futures Modernization Act (CFMA) 

in 2000. A principles-based system requires markets to meet certain public outcomes 

in conducting their business operations. For example, DCMs must continuously 

meet 18 core principles—ranging from maintaining adequate financial safeguards to 

conducting market surveillance—in order to uphold their good standing as a regulated contract market. 

MARKET OVERSIGHT

The CFTC’s Division of Market Oversight (DMO) is responsible for monitoring 

and evaluating a DCM’s operations. DMO conducts market surveillance of all activity on DCMs. While operational, DCMs must establish and devote resources toward 

an effective oversight program, which includes surveillance of all activity on their 

markets to detect and deter manipulation and trading abuses. The CFTC routinely 

assesses the regulatory and oversight activities of DCMs through regularly scheduled examinations of DCMs’ self-regulatory programs. The Commission currently 

regulates DCMs located in New York, Chicago, Kansas City, and Minneapolis. 

The CFTC’s market surveillance mission regarding DCM activity is to ensure 

market integrity and customer protection in the futures markets. Traders establishing positions on DCMs are subject to reporting requirements so that CFTC staff 

and the DCM can evaluate position sizes to detect and prevent manipulation. In addition, trade practice surveillance involves compilation and monitoring of transactional-level data by the Commission and the DCM to protect market participants 

from abusive trading such as wash sales, money laundering and trading ahead of 

customers. 

A key market surveillance mission is to identify situations that could pose a 

threat of manipulation and to initiate appropriate preventive actions. Each day, for 

the estimated 1,400 active futures and option contracts in the U.S., the CFTC market surveillance staff monitors the activities of large traders, key price relationships, 

and relevant supply and demand factors to ensure market integrity. 

Surveillance economists routinely examine trading in futures and options contracts that are approaching their expiration periods for any unusual trading patterns or anomalies. Regional surveillance supervisors immediately review unusual 

trading or anomalies to determine whether further action is warranted. Surveillance 

staff advise the Commissioners and senior staff of significant market developments 

as they occur and also conduct weekly surveillance meetings (non-public, closed 

meetings) so that the Commission will be prepared to take action if necessary. In 

addition to the transparency provided to the CFTC by position reporting by large 

traders, the Commission provides a degree of transparency to the public by publishing aggregate information in the CFTC’s weekly Commitment of Traders Report. 

As noted, surveillance of DCM trading is not conducted exclusively by the Commission. As SROs, DCMs have significant statutory surveillance responsibilities. 

Typically, however, surveillance issues are handled jointly by Commission staff and 

the relevant DCM. The Commission, while continuing to monitor market events, 

typically permits the DCM, as the front-line regulator, to utilize its self-regulatory 

authorities to resolve issues arising in its markets. If a DCM fails to take actions 

that the Commission deems appropriate, however, the Commission has broad emerVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00015 Fmt 6633 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
12 

gency powers under the CEA to order the DCM to take specific actions. The Commission has exercised its emergency authority four times in its history. 

FINANCIAL OVERSIGHT

The Commission’s Division of Clearing and Intermediary Oversight (DCIO) is responsible for and plays an integral role in ensuring the financial integrity of all 

transactions on CFTC-regulated markets. DCIO’s most important function is to prevent systemic risk and ensure the safety of customer funds. DCIO meets these responsibilities through an oversight program that includes the following elements: (1) 

conducting risk-based oversight and examinations of industry SROs responsible for 

overseeing Futures Commission Merchants (FCMs), commodity trading advisors, 

commodity pool operators, and introducing brokers, to evaluate their compliance 

programs with respect to requirements concerning fitness, net capital, segregation 

of customer funds, disclosure, sales practices, and related reporting and recordkeeping; (2) conducting risk-based oversight and examinations of all Commissionregistered derivatives clearing organizations (DCOs) to evaluate their compliance 

with core principles, including their financial resources, risk management, default 

procedures, protections for customer funds, and system safeguards; (3) conducting 

financial and risk surveillance oversight of market intermediaries to monitor compliance with the provisions of the CEA and Commission regulations; (4) monitoring 

market events and conditions to evaluate their potential impact on DCOs and the 

clearing and settlement system and to follow-up on indications of financial instability; and (5) developing regulations, orders, guidelines, and other regulatory approaches applicable to DCOs, market intermediaries, and their SROs. Collectively, 

these functions serve to protect market users, the general public and producers; to 

govern the activities of market participants; and to enhance the efficiency and effectiveness of the futures markets as risk management mechanisms. 

The DCOs that the Commission currently regulates are located in New York, Chicago, Kansas City, Minneapolis and London, England. The intermediaries overseen 

by the Commission are located throughout the United States and in various other 

countries. 

ENFORCEMENT

In Section 3 of the CEA, Congress provided that transactions subject to the Act 

‘‘are affected with a national public interest’’ because they constitute ‘‘a means for 

managing and assuming price risks, discovering prices, or disseminating pricing information through trading in liquid, fair and financially secure trading facilities.’’ 

The Commission’s Division of Enforcement (Enforcement) is responsible for prosecuting fraudulent, abusive and manipulative trading practices. Enforcement has a 

substantial role over maintenance and protection of principles of fairness and integrity in commodity markets. At any one time, Enforcement’s investigations (which 

are non-public) and pending litigation involve, on average, approximately 750 individuals and corporations. 

In protecting the national public interest associated with transactions subject to 

the Act, the Commission has broad authority to investigate and prosecute misconduct occurring in both the futures and cash markets. Included in this broad authority is Section 9(a)(2) of the CEA which prohibits manipulating or attempting to 

manipulate the price of any commodity in interstate commerce or for future delivery, cornering or attempting to corner any such commodity, and knowingly delivering or causing to be delivered false or misleading or knowingly inaccurate reports 

of crop or market information that affects or tends to affect the price of any commodity in interstate commerce. 

During the last five years, Enforcement has maintained a record level of investigations and prosecutions in nearly all market areas, including attempted manipulation, manipulation, squeezes and corners, false reporting, hedge fund fraud, offexchange foreign currency fraud, brokerage compliance and supervisory violations, 

wash trading, trade practice misconduct, and registration issues. Working closely 

with the President’s Corporate Fraud Task Force, Enforcement is staffed with 

skilled professionals who prosecute cases involving on-exchange transactions and, to 

the extent of the Commission’s jurisdiction, complex over-the-counter (OTC) transactions as well. Enforcement also routinely assists in related criminal prosecutions 

by domestic and international law enforcement bodies. Through those efforts, during 

the past five years (April 2003—March 2008), the CFTC has obtained more than 

2 billion dollars in monetary sanctions, which include civil monetary penalties and 

orders to pay restitution and disgorgement. 

In the energy sector, from December 2001 through the present, Enforcement investigated or prosecuted Enron and BP, dozens of other energy companies, and more 

13 

than one hundred energy traders (including a pending action against Amaranth). 

With respect to crude oil in particular, Enforcement staff in August 2007 announced 

a settlement for a charge of attempted manipulation in OTC crude oil markets 

against Marathon Petroleum Company, a subsidiary of Marathon Oil Corporation 

(Marathon Petroleum). In that action, which imposed a $1 million civil monetary 

penalty, the Commission entered an Order finding that Marathon Petroleum attempted to manipulate a price of spot cash West Texas Intermediate (WTI) crude 

oil by attempting to influence downward the Platts market assessment for spot cash 

WTI on November 26, 2003. The Platts market assessment for WTI is used as the 

price of crude oil in certain domestic and foreign transactions. At the time in question, Marathon Petroleum priced approximately 7.3 million barrels of physical crude 

per month off the Platts market assessment for WTI. 

CRUDE OIL TRADING ON FUTURES MARKETS AND OTHER MARKETS

The Commission’s oversight of oil futures trading focuses on the New York Mercantile Exchange or (NYMEX) and secondarily on the Intercontinental Exchange 

Europe (ICE Futures Europe)—the latter because one of its contracts cash settles 

on the price of the NYMEX WTI Light Sweet Crude futures contract. (Notably, 

crude oil futures products are also traded on some Exempt Commercial Markets, but 

those contracts are fairly low in trading volume.) 

NYMEX is a DCM with self-regulatory responsibilities and operates under the 

Commission’s oversight as provided by the CEA. NYMEX lists several crude oil futures contracts. The exchange’s highest volume crude oil contract is the WTI Light 

Sweet Crude Oil futures contract, which provides for physical delivery of oil in 

Cushing, OK. NYMEX’s Light Sweet Crude contract traded a volume of 122 million 

futures contracts in 2007. NYMEX also lists several cash settled futures contracts 

based on the Light Sweet Crude Oil futures contract price. NYMEX also lists futures contracts based on Brent blend crude oil, which settle on the price of the ICE 

Futures Europe Brent contract, as well as a Dubai crude oil calendar swap contract. 

In addition, NYMEX offers several financially-settled, cleared contracts, including 

differential and spread contracts involving prices of the WTI, Brent and Dubai crude 

oil futures contracts. 

ICE Futures Europe lists a Brent Crude Oil futures contract, a WTI Crude Oil 

futures contract that settles on the price of the NYMEX light sweet crude oil contract, and a Middle Eastern Sour Crude futures contract. The Brent and WTI contracts are very actively traded, while the Middle Eastern Sour Crude contract trades 

much less frequently. 

ICE Futures Europe is a UK Registered Investment Exchange and is regulated 

by the UK’s Financial Services Authority (FSA). The U.S.-based members of ICE 

Futures Europe were granted permission by Commission staff to directly access the 

Exchange’s trading system from the U.S. pursuant to a Commission no-action letter 

issued to ICE Futures Europe’s predecessor, the International Petroleum Exchange 

Limited, on November 12, 1999, as amended. 

Pursuant to the no-action letter’s terms and conditions and information—sharing 

arrangements, CFTC surveillance staff knows, among other things, when ICE Futures Europe proposes to list new contracts to be made available from the U.S., the 

volume of trading originating from the U.S., the identities of members who have direct access to the trading system in the U.S., and when there are material changes 

to any aspect of the information provided that resulted in the issuance of the noaction letter. Pursuant to CFTC-FSA information—sharing arrangements, CFTC 

surveillance staff also receives ICE Futures Europe’s member position reports for 

its WTI Crude Oil futures contract on a weekly basis (daily during the week prior 

to contract expiration). Thus, CFTC surveillance staff knows the positions and identities of members/customers who meet or exceed position-reporting requirement levels in the ICE Futures Europe WTI contract, and can consider that data along with 

the large trader reporting information that it receives from NYMEX for its counterpart contract. 

FOREIGN BOARDS OF TRADE

The CFTC employs a ‘‘no-action’’ process when foreign boards of trade (FBOTs) 

seek to provide electronic screen access to the U.S., but without registering as a 

DCM. With the advent of the ICE Futures Europe WTI contract in 2006, the CFTC 

undertook a thorough review of its FBOT policy. The Commission concluded that 

the best way to handle the issue was to continue its no-action approach, a response 

that reflects the internationally accepted ‘‘mutual recognition’’ approach used by regulators in many developed market jurisdictions to govern access to foreign electronic 

exchanges by persons located in their jurisdictions. This approach generally is based 

14 

upon a review of, and ongoing reliance upon, the foreign market’s ‘‘home’’ regulatory 

regime, and is designed to maintain a threshold level of regulatory protections while 

avoiding the imposition of duplicative regulation. 

The CFTC has followed the no-action approach since 1996 and it has never experienced any market integrity or customer protection problems. The no-action procedure provides the CFTC with flexibility in dealing with the particular foreign exchanges and different CFTC practices. The Commission held an FBOT hearing in 

June 2006, including a related open public comment opportunity, during which market users, foreign exchanges and even competitive domestic exchanges that compete 

with FBOTs overwhelmingly confirmed the success of the CFTC’s approach in terms 

of market and customer protection and access to additional products. Subsequently, 

the CFTC issued a Statement of Policy re-affirming the use of the FBOT no-action 

process, but also enhancing it through the imposition of information-sharing conditions where no-action relief is sought for FBOT contracts that could adversely affect 

the pricing of contracts traded either on a DCM or on any cash market for commodities subject to the CEA. 

On November 17, 2006, the CFTC and the UK FSA signed a Memorandum of Understanding (MOU) concerning consultation, cooperation and the exchange of information related to market oversight. The MOU established a framework for the 

CFTC and FSA to share information that the respective authorities need to detect 

potential abusive or manipulative trading practices that involve trading in related 

contracts on U.S. and UK derivative exchanges. Since the adoption of the MOU, the 

CFTC and FSA have been holding monthly conference calls to discuss matters of 

mutual interest including trading on ICE Futures Europe. Commission staff has 

found that the 6 MOU has strengthened information-sharing on an ongoing basis 

between the two regulatory authorities. 

EXEMPT COMMERCIAL MARKETS

In the Commodity Futures Modernization Act of 2000 (CFMA), Congress enacted 

special provisions in the CEA to govern Exempt Commercial Markets (ECMs), which 

are electronic marketplaces for commercial participants to trade contracts in energy 

and certain other commodities. ECMs have been evolving over time since then, such 

that today, certain ECM contract settlement prices link to DCM futures contract 

settlement prices. Linkage of contract settlement prices was not something that was 

contemplated at the time of the CFMA. 

Last September, the CFTC conducted an extensive public hearing on ECMs, and 

found that certain energy futures contracts traded on ECMs may be serving a significant price discovery function. This raised the question of whether the CFTC has 

the necessary authority to police the ECM markets for manipulation and abuse. The 

Commission concluded that changes to the CEA would be appropriate as a result 

and, to that end, in October 2007 the Commission recommended legislative changes 

in a Report delivered to Congress. Specifically, the Commission recommended that 

significant price discovery contracts on ECMs be subject to the same position limit 

and position accountability core principle that applies to contracts traded on DCMs. 

In addition, its recommendations would further require: 1) large trader position reporting on significant price discovery contracts on ECMs; 2) self-regulatory responsibilities for the ECM; and 3) CFTC emergency authority over these contracts. 

We are pleased that the Commission’s recommendations were endorsed by the 

President’s Working Group on Financial Markets, and have been well received in 

Congress. In December, these recommendations were included in legislation that 

moved forward in both the House of Representatives and the Senate. Both bills 

largely adopt the CFTC’s recommendations on the need for enhanced oversight over 

significant price discovery contracts traded on ECMs, including position limits and 

position accountability. The modest differences between the bills are being worked 

out as part of the Conference on the Farm Bill, and we are hopeful that Congress 

will take final action on these proposals soon to give the CFTC these additional and 

necessary authorities. 

BILATERAL OVER-THE-COUNTER TRADING

Much crude oil trading also takes place by what is known as ‘‘over-the-counter’’ 

(OTC) trading. This trading is typically non-standardized and between two sophisticated participants. The CFTC does not regulate privately-negotiated OTC contracts, 

nor does it regulate cash markets or forward markets. However, we have the tools 

to adequately police the markets falling under CFTC jurisdiction. The typical OTC 

market transaction involves a sophisticated market participant’s request to a swap 

dealer to structure an OTC transaction. The dealer facilitates the customer by taking the opposite side of the customer’s position. The dealer then turns to the futures 

15 

markets to offset the risk that it has taken on. (We see the actions of OTC dealers 

in our Large Trader Reporting System as explained below.) 

The first thing to recognize about OTC contracts is that they are typically 

benchmarked to NYMEX futures prices or to cash market indexes. In terms of administering the anti-manipulation provisions of the CEA, our current authority and 

our current surveillance program are sufficient to detect an attempted manipulation 

of the NYMEX futures price to benefit an off-exchange OTC position. 

Our current authority also gives us the ability to ask what we call ‘‘reportable 

traders’’ in the futures markets to reveal their OTC positions, as well as their cash 

market and forward market positions. If required, we also have subpoena authority. 

We have used this authority to help bring 50 enforcement actions in energy markets 

in recent years. 

The enactment of the CFMA brought about multilateral clearing of OTC positions 

at futures clearinghouses. As a result, OTC trades become transparent to the CFTC 

through the clearing process. For 2007, approximately 224 million OTC contracts 

cleared through NYMEX and the InterContinental Exchange (ICE). In fact, as traders in the OTC markets have become more aware of credit considerations and the 

benefits of transparency, they have been moving their positions onto exchanges 

where the exchange clearinghouse enhances credit worthiness and the market is 

transparent. 

USING DATA TO OVERSEE THE MARKETS

The CFTC receives millions of data points every day about trading activity in the 

markets. The agency’s Large Trader Reporting System is the cornerstone of our surveillance system and is used to look at data. Clearing members, FCMs, foreign brokers and other traders file confidential electronic reports with the CFTC each day, 

reporting positions of each large trader on each DCM. In the NYMEX WTI contract, 

for instance, a trader with a position exceeding 350 contracts in any single expiration is ‘‘reportable.’’ Large trader positions reported to the CFTC consistently represent more than 90% of total open interest in the NYMEX WTI contract, with the 

remainder being smaller traders who do not meet reporting thresholds. 

When a reportable trader is identified to the CFTC, the trader is classified either 

as a ‘‘commercial’’ or ‘‘non-commercial’’ trader. A trader’s reported futures position 

is determined to be commercial if the trader uses futures contracts for the purposes 

of hedging as defined by CFTC regulations. Specifically, a reportable trader gets 

classified as commercial by filing a statement with the CFTC (using the CFTC Form 

40) that it is commercially ‘‘... engaged in business activities hedged by the use 

of the futures and option markets.’’ However, to ensure that traders are classified 

consistently and with utmost accuracy, CFTC market surveillance staff checks the 

forms and re-classifies the trader if they have further information about the trader’s 

involvement with the markets. 

In fact, a reportable participant may be classified at the CFTC as non-commercial 

in one market and commercial in another market, but is never classified as both 

in the same market. For instance, a financial institution trading Treasury Notes 

might have a money management unit whose trading positions are classified as noncommercial but a banking unit that is classified as commercial. Reporting firms 

must file Form 102 to identify each account, and this information allows the CFTC 

to relate separate traders to a single higher level of ownership. 

In addition to the breakdown between commercial and non-commercial categories, 

the large trader data can be filtered by type of trading activity. For example, on 

the commercial side, the CFTC can sort the data by more than 20 types of institutions, ranging from agricultural merchants and livestock feeders to mortgage originators. Traders that are non-commercial include commodity trading advisors, commodity pool operators (managed money traders), and floor brokers and traders. 

Using data from the Large Trader Reporting System, the CFTC also publishes a 

weekly breakdown of reporting positions of each Tuesday’s open interest known as 

the Commitments of Traders (COT) report. COT reports are published for markets 

in which 20 or more traders hold positions above CFTC-established reporting levels. 

COT reports are available on the CFTC’s public website every Friday at 3:30 PM 

in both a short and long format. The short report shows open interest separately 

by reportable and non-reportable positions. The long report, in addition to the information in the short report, shows the concentration of positions held by the largest 

four and eight traders and groups the data by crop year, where appropriate. For reportable positions, additional data is provided for commercial and non-commercial 

holdings, spreading, changes from the previous report, percentage of open interest 

by category, and numbers of traders. 

16 

SPECULATION IN THE COMMODITIES MARKETS

The current market environment has brought questions about the role that speculators play in affecting prices in the futures markets. The proper and efficient functioning of the futures markets requires both speculators and hedgers. While certain 

targeted controls on speculation are appropriate, speculators, as a class, provide the 

market liquidity to allow hedgers to manage various commercial risks. Unnecessary 

limitations on the amount of speculation that an individual or entity may engage 

in could limit the amount of liquidity in the marketplace, the ability of hedgers to 

manage risks, and the information flow into the marketplace, which could in turn 

negatively affect the price discovery process and the hedging function of the marketplace. 

While speculation is critical to well-functioning markets, excessive speculation can 

be detrimental to the markets. Under Section 4a of the CEA, the concept of ‘‘excessive speculation’’ is based on trading that results in ‘‘sudden or unreasonable fluctuations or unwarranted changes in the price’’ of commodities underlying futures 

transactions. The CEA specifically makes it a violation of the Act to manipulate the 

price of a commodity in interstate commerce or for future delivery. The CEA does 

not make excessive speculation a per se violation of the Act, but rather, requires 

the Commission to enact regulations to address such trading (for example, through 

speculative position limits). 

The Commission has utilized its authority to set limits on the amount of speculative trading that may occur or speculative positions that may be held in contracts 

for future delivery. The speculative position limit is the maximum position, either 

net long or net short, in one commodity future (or option), or in all futures (or options) of one commodity combined, that may be held or controlled by one person 

(other than a person eligible for a hedge exemption) as prescribed by a DCM and/ 

or by the Commission. Moreover, CEA Section 5(d)(5) requires that a DCM, ‘‘[t]o reduce the potential threat of market manipulation or congestion, especially during 

trading in the delivery month... shall adopt position limitations or position accountability for speculators, where necessary and appropriate.’’ 

All agricultural and natural resource futures and options contracts are subject to 

either Commission or exchange spot month speculative position limits—and many 

financial futures and options are as well. With respect to such exchange spot month 

speculative position limits, the Commission’s guidance specifies that DCMs should 

adopt a spot month limit of no more than one-fourth of the estimated spot month 

deliverable supply, calculated separately for each contract month. For cash settled 

contracts, the spot month limit should be no greater than necessary to minimize the 

potential for manipulation or distortion of the contract’s or underlying commodity’s 

price. 

With respect to trading outside the spot month, the Commission typically does not 

require speculative position limits. Under the Commission’s guidance, an exchange 

may replace position limits with position accountability for contracts on financial instruments, intangible commodities, or certain tangible commodities. If a market has 

accountability rules, a trader—whether speculating or hedging—is not subject to a 

specific limit. Once a trader reaches a preset accountability level, however, the trader must provide information about his position upon request by the exchange. In addition, position accountability rules provide an exchange with authority to restrict 

a trader from increasing his or her position. 

Finally, in order to achieve the purposes of the speculative position limits, the 

Commission and the DCMs treat multiple positions held on a DCM’s market that 

are subject to common ownership or control as if they were held by a single trader. 

Accounts are considered to be under common ownership if there is a 10 percent or 

greater financial interest. The rules are applied in a manner calculated to aggregate 

related accounts. 

Violations of exchange-set or Commission-set limits are subject to disciplinary action, and the Commission, or a DCM, may institute enforcement action against violations of exchange speculative limit rules that have been approved by the Commission. To this end, the Commission approves all position limit rules, including those 

for contracts that have been self-certified by a DCM. 

OFFICE OF THE CHIEF ECONOMIST STUDY OF TRENDS IN THE CRUDE OIL MARKET

The CFTC’s Office of the Chief Economist (OCE) closely tracks developments in 

the crude oil markets. Crude oil prices have risen significantly during the past few 

years and are currently above $100/barrel. Concurrently, open interest in WTI crude 

oil futures has expanded dramatically, growing from about 1 million contracts in 

2004 to more than 2.8 million contracts during the most recent week. 

17 

OCE has studied these markets to better understand the components of this rapid 

growth. Our studies find three major trends in crude oil markets. First, we see similar rates of growth for both commercial and non-commercial interests. Non-commercial participants are commonly considered speculators. Non-commercial share of 

total open interest has increased marginally from 31% to about 37% over the past 

three years. It is important to understand that the majority of non-commercial positions are in spreads; that is, taking a long position in one contract month and a 

short position in another. 

Second, much of the growth in open interest is concentrated in futures contracts 

that expire after 12 months. Whereas contracts beyond one year were rare in 2000, 

we are now seeing significant open interest in contracts with expires out to five 

years. In fact, contracts beyond six years are now available at NYMEX. Figures 1a 

and 1b below highlight these two trends. 

Figures 1a and 1b also highlight the fact that commercial traders taking short positions to hedge rely on non-commercial traders to take the opposite side of their 

trades. Were fewer non-commercial positions opened, hedging costs would likely increase. In this light, commercial traders demand hedging services that are supplied 

by non-commercial traders. The supply and demand for hedging services intimately 

ties hedgers and speculators together in futures markets. 

The third major trend during the past few years in crude oil markets is that swap 

dealers now hold significantly larger positions in crude oil. These dealers, who take 

the short sides of over-the-counter swaps against commodity index traders, hedge 

this exposure with long futures positions in crude oil. This development has altered 

the traditional role of commercial traders. Previously, commercial traders predominately hedged long cash positions using short futures contracts. The recent development has swap dealers (also classified as commercial traders) hedging their short 

swap positions with long futures. Figures 2a and 2b below depict these differences. 

Figure 2b also demonstrates the growth in swap dealer trading in the near-term 

futures contract, which largely represents flows from commodity index trading. 

Given the substantial increase in open interest in crude oil futures markets, OCE 

utilizes the Commission’s extensive data to examine the role of all market participants and how their positions might affect prices. Although longer-term studies 

show a slight increase in non-commercial market share in the crude oil market, 

OCE analysis shows that the more recent increase in oil prices to levels above $100/ 

barrel has not been accompanied by significant changes to the participants in this 

market. Figure 3 below shows that the number of commercial and non-commercial 

traders has remained nearly constant over the past 22 months, with about 120 commercial and 310 non-commercial participants in the market. 

OCE has also studied the impact of speculators as a group in oil markets during 

the most recent price run-up. Specifically, we have closely examined the relation between futures prices and positions of speculators in crude oil. Our studies have consistently found that when new information comes to the market and prices respond, 

it is the commercial traders (such as oil companies, utilities, airlines) who react first 

by adjusting futures positions. When these commercial traders adjust their futures 

positions, it is speculators who are most often on the other side of the trade. Price 

changes that prompt hedgers to alter their futures positions attract speculators who 

change their positions in response. Simply stated, there is no evidence that position 

changes by speculators precede price changes for crude oil futures contracts. Instead, changes in commercial positions significantly precede crude oil futures price 

changes. 

To highlight this fact more clearly, Figure 4 below plots the prices and the market 

share of one group of active speculators (managed money traders) over the past 22 

months. Notably, while WTI contract prices have more than doubled during the past 

14 months, managed money positions, as a fraction of the overall market, have 

changed very little. Speculative position changes do not amplify crude oil futures 

price changes. More specifically, the recent crude oil price increases have occurred 

with no significant change in net speculative positions. 

OCE has also studied position changes of commercial and non-commercial traders 

by category, finding similar results. In no case do we find net position changes of 

any category of non-commercial traders significantly preceding changes in crude oil 

futures prices. Figure 5 below highlights the fact that commercial and non-commercial open interest has grown during the most recent 22 months, but generally remains balanced between long and short positions for each trader group. 

OCE staff has also studied the propensity of various market participants to be 

trading on the same side of the market concurrently—a phenomenon commonly 

known as ‘‘herding.’’ Although many rules govern the behavior of individual traders, 

the Commission recognizes that concurrent trading by groups of traders—‘‘herds’’— 

can detrimentally affect markets. Herding behavior can represent an impediment to 

18 

the efficient functioning of markets if market participants follow the herd blindly, 

causing prices to over-adjust to new information. The OCE study found little evidence of significant herding in crude oil futures markets. In fact, when herding was 

found, it appeared to be beneficial, and not destabilizing for prices—buy herding appeared only when prices were falling and price increases were unrelated to herding 

activity. 

CONCLUSION

Looking at the trends in the marketplace, combined with studies on herding behavior and the impact of speculators in the markets, there is little evidence that 

changes in speculative positions are systematically driving up crude oil prices. 

Given the relative stability of the makeup of participants and their positions in the 

markets and the absence of evidence that speculation has caused oil price changes, 

it appears that fundamentals provide the best explanation for crude oil price increases. These fundamentals can be either broad factors that affect many markets— 

like the value of the dollar or general inflation fears—or factors particular to a market—such as strong demand from China and India for crude oil and other commodities. In addition, geopolitical events, such as tensions involving Venezuela, Nigeria, 

Iran, Iraq, Turkey and the Kurds have affected commodity markets, especially the 

energy and precious metals markets. 

Concerns about the high price of oil are not unique to the United States. I recently presented these findings to the International Energy Agency conference in 

Paris which included representatives from 40 different countries, OPEC, industry 

economists and traders. Our findings were supported by many of the conference presenters and attendees who have conducted their own research on the topic. Given 

the widespread interest in crude oil in particular, it is something I am certain we 

will continue to monitor closely, as will my counterparts around the world. 

This is a dynamic time in the futures markets, given the growth in trading volume, product innovation and complexity, and globalization—in all commodities, including energy. The Commission will continue to work to promote competition and 

innovation, while at the same time, fulfilling our mandate under the CEA to protect 

the public interest and to enhance the integrity of U.S. futures markets. 

The CHAIRMAN. Alright. Thank you very much for your testimony. Ms. Emerson, why don’t you go right ahead? 

STATEMENT OF SARAH A. EMERSON, MANAGING DIRECTOR, 

ENERGY SECURITY ANALYSIS, INC., WAKEFIELD, MA 

Ms. EMERSON. Good morning, Mr. Chairman, distinguished committee members. I’m the Managing Director of Energy Security 

Analysis, an Energy Research Firm. I oversee all petroleum market 

analysis for my firm. I have been asked today to provide a physical 

market context for the increased oil prices to over $100 and the 

role of the institutional investors in the oil markets. 

We are witnessing striking developments in global markets. The 

price of crude oil has doubled since the beginning of 2007 and is 

at or above $100 today. The dollar has fallen and is now worth only 

about two-thirds of a Euro. Oil exporting countries are pumping 

petrodollars into the global economy. Some estimates put that 

amount at $4 trillion as of the end of 2007. This is the status quo. 

As shocking as it seems it appears to be relatively stable because 

these developments reinforce each other. The weak dollar cushions 

the impact of high oil prices on consumers outside of the United 

States. The petrodollars provide liquidity of investment which 

helps grow the global economy, especially outside of the United 

States. 

These two factors support oil demand growth, again outside the 

United States, in spite of the higher price. Excuse me. Meanwhile 

the weak dollar and the high oil price encourage institutional investors to buy commodities especially oil as a hedge against inflation. Now as we witness these developments in global markets it’s 

19 

important to keep in mind that we have reached this status quo 

in large part because of what is taking place in the underlying 

physical market for oil. 

During the 1980s and 1990s as you know, the global oil markets 

was characterized by over supply. The capacity to produce oil significantly exceeded demand. Nominal prices were flat. Real prices 

fell. These low oil prices supported oil demand not only in the 

transportation sectors of the industrialized countries, but also in 

the power generation, industrial and now chemical transportation 

sectors of the developing world. 

As a result global oil demand caught up with the capacity to 

produce oil. Spare crude production capacity has been reduced to 

a bare minimum. To illustrate, in the 1980s there was as much as 

15 percent spare crude oil production capacity in the global market. 

By the 1990s that number had fallen to 7 percent. Now we are 

down to 2 to 3 percent. 

In the meantime with low consumer prices for much of the last 

two decades, refining has been a fairly low margin business discouraging capacity investment. Except in countries where refiners 

are at least partially protected by government policies such as price 

subsidies or import controls. In sum, today both crude oil production and global oil refining have very limited spare capacity when 

compared to the previous two decades. 

In addition to these structural factors, there have also been more 

transient factors that have contributed to crude oil march from $30 

to $100. Some have been geopolitical events already referenced this 

morning, such as interruptions to oil flows in Iraq and Nigeria or 

just the threat to an interruption of oil from Venezuela or Iran. 

There have also been supply chain mishaps, like pipeline explosions and of course, the hurricanes hitting our own refining facilities in the Gulf coast. 

In the past, these surprise events might have had a limited or 

short-lived price impact as alternative supplies flowed into the 

market. But today, regardless of the severity of the threat they 

pose to the supply of crude or products, the impact of these events 

on prices is tremendous because again of the absence of spare capacity, no alternative suppliers. We are still living in a world with 

little margin for error. 

These factors have helped lift crude oil prices from $30 to at least 

$50 or $60. So this brings us to 2007 and 2008 and the current run 

up in oil prices. At the end of 2006, oil prices were sliding and 

OPEC decided to cut production by about 1.7 million barrels per 

day. This decision had a significant impact on the global balance 

for oil in 2007. 

Let me explain. In a typical year, on a global basis, oil demand 

exceeds oil supply in the first and fourth quarters of the year and 

inventories typically climb. In the second and third quarters, oil 

supply typically exceeds oil demand and inventories typically rise. 

In 2007 oil demand exceeded oil supply in the first, third and 

fourth quarters and was essentially balanced in the second quarter. 

In short the global market did not build supplies last summer to 

use this winter. On average in 2007, global oil demand exceeded 

global oil supply by somewhere between 500,000 barrels per day 

20 

1Sarah A. Emerson is the Managing Director of Energy Security Analysis, Inc (ESAI), an 

independent energy research and forecasting firm located just outside of Boston, Massachusetts. 

Ms. Emerson joined ESAI when the petroleum consulting practice was launched in 1986. 2 ‘‘Oil Producers See the World and Buy it Up,’’ NYT, Wednesday, November 28, 2007, page 

A1. 

and one million barrels per day. A rally in oil prices was a forgone 

conclusion at the end of 2007 or at least in the second half of 2007. 

There were of course, other factors that affected the oil price in 

2007. But this basic story of demand outstripping supply has been 

the physical market backdrop for the recent run up in prices. Now 

we get to the critical question. Can it account for the entire move 

to $110? 

I personally do not think so. As I said at the beginning of these 

comments, institutional investors have identified oil as an attractive investment. This is in part, in large part, because the physical 

market had not discouraged the community investors who want to 

buy and hold oil as a portfolio investment. 

Let me conclude by saying some relief is on its way in the physical market. Hope OPEC has increased production significantly 

since late 2007, although perhaps not as much as some would like 

them to. Oil demand indeed is slowing because of the economic 

slow down here in the United States. 

But the fundamentals have not turned yet enough. They haven’t 

flipped enough to discourage investors who want to invest in and 

hold oil as a portfolio investment. In the meantime, we on the 

physical side see nothing in the financial markets themselves that 

indicates a desire to sell crude oil. Thank you very much. 

[The prepared statement of Ms. Emerson follows:] 

PREPARED STATEMENT OF SARAH A. EMERSON1 MANAGING DIRECTOR, ENERGY

SECURITY ANALYSIS, INC. WAKEFIELD, MA 

Good morning Mr. Chairman and distinguished committee members. I am honored to testify before you today. I have been asked to provide a physical market context for the increase in oil prices to over $100 and the role of institutional investors 

in the oil markets. 

INTRODUCTION

We are witnessing striking developments in the global markets. The price of crude oil has doubled since the beginning of 2007 and is at or above $100 per barrel. The 

dollar has fallen precipitously and is now worth only about 2/3 of a Euro. Oil exporting countries are pumping ‘‘petrodollars’’ into the global economy. Some estimates 

put that amount at $4 trillion dollars as of the end of 2007.2

This is the status quo, and as shocking as it seems, it appears to be relatively 

stable. The weak dollar cushions the impact of the high oil price on consumers outside of the U.S., the petrodollars provide liquidity in investment which helps grow 

the global economy, especially outside of the U.S. And one could argue the Fed’s 

monetary policy, designed to stimulate our slowing economy by lowering interest 

rates, keeps the dollar weak, which in turn encourages investors to buy commodities, especially oil, as a hedge against inflation. 

But, as we witness these developments in the financial markets, it is important 

to keep in mind that oil prices could only display this kind of strength because of 

what has taken place in the physical market for oil. 

Over the 20 year period prior to 2003, the global oil market was characterized by 

over-supply. The capacity to produce oil significantly exceeded demand. Nominal 

prices were flat and real prices fell. 

Years of relatively low oil prices supported oil demand not only in the transportation sectors of the industrialized countries, but also in the power generation, industrial and now chemical and transportation sectors of the developing world. As 

a result, global oil demand caught up with the capacity to produce oil. The spare 

capacity held by OPEC has been reduced to a bare minimum. Specifically, in the 

21 

1980s, there was as much as 15 percent sparecrude oil production capacity in the 

global market. By the 1990s, that number had fallen to 7 percent. Now, we are 

down to 2–3 percent. 

In the meantime, with low consumer prices for much of the last two decades, refining has been a fairly low-margin business, discouraging investment except in 

countries where refiners are at least partially protected by government policies such 

as price subsidies or import controls. In sum, both global crude production and global refining have very limited spare capacity relative to the previous two decades. 

In addition to these structural factors, there have also been more transient factors 

that have contributed to crude oil’s march from $30 to $100. Some have been geopolitical events such as interruptions to oil flows in Iraq and Nigeria or threats to 

the flow of oil in Venezuela or Iran. There have also been supply chain mishaps like 

pipeline explosions or hurricanes hitting refining facilities. In the past, these surprise events might have a limited or short lived price impact. 

What is most striking about these events today is that, regardless of the severity 

or the duration of the threat they pose to the supply of crude or products, their impact on prices is tremendous because of the absence of spare capacity (or alternative 

supplies). We are still living in a world with little margin for error. 

This brings us to 2007/2008 and the current run up in oil prices. At the end of 

2006, oil prices were sliding and OPEC decided to cut production by as much as 1.7 

million b/d. This decision had a significant impact on the global balance for oil in 

2007. In a typical year, on a global basis, oil demand exceeds oil supply in the first 

and fourth quarters and inventories decline. In the second and third quarters, oil 

supply exceeds oil demand and inventories typically rise. In 2007, oil demand exceeded oil supply in the first, third and fourth quarters and was essentially balanced in the second quarter. In short, the global market did not build supplies last 

summer to use this winter. The global market dug a big hole. On average, in 2007 

global oil demand exceeded global oil supply by somewhere between 500,000 b/d and 

1.0 million b/d. A rally in oil prices in late 2007 was a foregone conclusion. 

There were other factors that affected the oil price in 2007, but this basic story 

of a tight global market has been the physical market backdrop for the run-up in 

prices. Can it account for the entire move to $110? No I do not think so. But, the 

physical market has not discouraged or disciplined the community of investors who 

want to buy and hold oil as a portfolio investment. 

Relief is on its way in the physical market. OPEC increased production significantly in the latter half of 2007 and oil demand is slowing because of the economic 

slowdown here in the U.S. But the fundamentals have not turned 

enough . . . yet . . . to discourage investors who want to invest in and hold oil. 

In the meantime, we see nothing in the financial markets that indicates a desire 

to sell crude oil. 

ATTACHMENT.—THE FACTORS ENCOURAGING HIGH OIL PRICES

BACKGROUND PAPER

BY SARAH A. EMERSON

Sarah A. Emerson is the Managing Director of Energy Security Analysis, Inc 

(ESAI), an independent energy research and forecasting firm located just outside of 

Boston, Massachusetts. Ms. Emerson adapted this paper from one she wrote for the 

Electric Power Research Institute. 

During the 1950s, 1960s, and the early 1970s, oil prices were ‘‘posted’’ or set by 

the major integrated oil companies. Indeed, the volume of trade in crude oil spot 

markets accounted for only about 15 percent of international crude oil transactions. 

Moreover, spot transactions were possible only because the major oil companies 

needed to balance their own supply and demand, unloading small surpluses and covering minor deficits in the spot markets. The oil crises of 1973–74 and 1979–80 led 

to a threefold increase in prices, the adoption of fixed prices by OPEC, and the 

abandonment of fixed volume contracts between OPEC member countries and their 

customers. Higher world prices for oil stimulated non-OPEC production and cut 

global oil demand. As a result, in the market for the marginal barrel of crude (the 

spot market) prices fell below OPEC’s elevated and fixed price. Not surprisingly, 

independent refiners, traders and even the integrated majors bought more and more 

crude in the spot market. By the early 1980s, crude oil transactions at spot prices 

or prices tied to the spot market accounted for more than 50 percent of total international crude oil transactions. 

Within OPEC, the role of swing producer in defense of higher prices became increasingly untenable for Saudi Arabia. Ultimately, Saudi Arabia abandoned this 

22 

3 A chart comparing the net long position of the non-commercials with the price of WTI is included in the Appendix. 4 A global balance that compares global oil demand with global supply is presented in the Appendix. Spare production capacity is held by OPEC and is presented graphically later in the 

text in Chart C. 

role, a market share war ensued and prices collapsed in 1986. Since 1986, almost 

all of the world’s oil has been sold bilaterally with transactions linked to some kind 

of market-based pricing, such as netbacks or formulas tied to spot, and more recently, futures prices. 

. . . Gives Way to Market Forces 

The emergence of spot and futures markets in oil has led to two decades of market forces as the organizing principle of the global oil sector. The deregulation of 

domestic oil industries and the liberalization of petroleum product pricing have proceeded all over the world as countries have opted to integrate into the large, transparent and relatively low priced global oil market. The view that market forces, 

rather than government policies, were best suited to allocate resources equitably 

was mirrored by the rise of Reagan-Thatcher laissez-faire conservatism of the 1980s 

and the eventual collapse of the Soviet bloc by the early 1990s. The devaluation of 

the Russian ruble and the Asian financial crisis later in the 1990s showed the folly 

of policies that ran counter to market forces in global capital markets. More recently, the market-friendly approach adopted by the Bush White House and China’s 

accession to the World Trade Organization (WTO) have again underscored the dominance of the ‘‘market.’’ 

Meanwhile, financial institutions have become important participants in the futures markets, buying and selling paper barrels of oil. Futures markets and the liquidity provided by speculators have transformed the global oil market from one 

dominated by month-to-month pricing to one driven by minute-to-minute pricing. A 

striking example of the influence of speculation in the futures market on short-term 

price direction has been the impact of the net position (long or short) of the noncommercials (non-hedgers) on the price of WTI on the NY Mercantile Exchange 

(NYMEX).3

It is not just the existence of spot and futures markets and the political preference 

for unfettered markets, however, that has allowed the market to reign in oil. Over 

most of the last 20 years, the global oil market has been characterized by over supply. The capacity to produce oil has significantly exceeded demand. Nominal prices 

have been flat and real prices have fallen. 

The Era of Market Forces May be Coming to an End 

Now as we face the next 20 years, the era of ‘‘market’’ as the primary organizing 

principle may be coming to an end. Market forces are under attack from many sides. 

This is, in part, due to the state of the physical market itself. Years of relatively 

low oil prices have supported oil demand not only in the transportation sectors of 

the industrialized countries, but also in the power generation, industrial and now 

chemical and transportation sectors of the developing world. Global oil demand has 

caught up with the capacity to produce oil. The spare capacity held by OPEC has 

been reduced to a bare minimum. That cushion will not be replaced overnight, unless something distinctly slows oil demand growth.4

In the meantime, with low consumer prices for much of the last two decades, refining has been a fairly low margin business, discouraging investment except in 

countries where refiners are at least partially protected by government policies such 

as price subsidies or import controls. In sum, both global crude production and global refining are capacity constrained relative to the previous two decades. 

But that is only part of the physical market story. The market impact of the capacity crunch has been intensified by government efforts to protect the environment. 

Policies to cut polluting emissions have led to fuel specification changes that have 

chipped away at the profitability of refining by forcing refiners to focus on investments to refine predominantly medium sour crude into clean low sulfur transportation fuels rather than investments to expand capacity. These refining investments 

have barely kept pace with demand for cleaner products, so the global market for 

clean products is supported not only by tight distillation capacity but also limits on 

the upgrading and desulphurization capacity available to make cleaner and lighter 

fuels. 

High Oil Prices 

In thinking about the factors that have led crude oil prices from $30 to almost 

$100, some are structural factors that will take years to change. Others are more 

23 

* Charts A–F has been retained in committee files. 

5The values in this chart are the judgment of the author. 

6Data for chart B is based on the BP Statistical Review and ESAI’s own database. 

7Data for chart C comes from ESAI’s own proprietary database. ESAI maintains a countryby-country database of supply, demand, inventories, refinery operations, crude production, production capacity for crude oil and each petroleum product for the entire world. All of ESAI’s 

market analysis is based on a bottom-up approach to analyzing supply and demand at the national regional and global level. 

transient factors that change almost daily. As shown in the chart A* the structural 

factors include basic items such as weighted average production costs and transportation, but they also include supply chain factors such as the preference for just in 

time inventories, limited refining capacity and thin spare production capacity.5

These supply chain factors are not easily or quickly changed and they have made 

the current era of pricing a departure from the previous 20 years when companies 

carried a lot of inventory and there was significant spare refining and production 

capacity. 

Charts B and C illustrate the elimination of spare capacity in both refining and 

crude oil production. In the case of global refining capacity, since 1990, the global 

utilization rate (here defined as global demand/global capacity) has exceeded 90 percent, but since 2004 has exceeded 95 percent.6 2004 was a remarkable year because 

oil demand grew very quickly around the world, but especially in the U.S. and 

China. Indeed, China’s demand growth was extraordinary. Even though China’s oil 

demand growth has slowed since then, that one-year spike drew a great deal of attention. China’sgrowth will continue on a steady pace, but is unlikely to return to 

2004 levels. In any event, the enormous increase in oil demand in 2004 led to a commensurate increase in crude oil production, especially in OPEC countries.7 That 

jump in output eliminated a significant volume of spare capacity. Since then, some 

spare capacity has been rebuilt as some new fields are brought on line in OPEC 

countries and as global oil demand has slowed down distinctly in 2005–2007. Indeed, oil demand growth in 2005 through 2007 has averaged about 1.2 million b/ 

d whereas oil demand in 2004 was roughly 3.0 million b/d on the back of the Chinese surge. 

The other factors included in chart A are more transient factors, which may have 

a shorter life span than structural factors. They include short-term developments 

in supply and demand, geopolitical events involving oil-producing countries like Nigeria, Iraq, Iran and Venezuela, supply chain mishaps like pipeline explosions or 

hurricanes hitting refining facilities. There is also speculation when noncommercial 

traders buy crude oil either as a short-term speculative investment or a hedge 

against something else like inflation. Each of these categories of factors has different impacts. Under the supply and demand developments, some factors have 

more lasting impact. The previously mentioned oil demand surge in 2004 was driven, in part, by a sudden acceleration in China’s oil use. That was really a one-year 

phenomenon, although China continues to post healthy demand growth. Another example is the start up of a new oil field or a warmer or colder than normal winter. 

The rest of the transient factors are largely surprise events that are generally difficult to predict, but also relatively short lived. Regardless of the severity or duration of the threat these transient factors pose to the supply of crude or products, 

their impact on prices can be tremendous because of the absence of spare capacity 

in the global supply chain. This is well known by speculators who are inclined to 

‘‘buy’’ oil at the first news of an actual or potential supply interruption. 

Will Market Forces Bring Oil Prices Down? 

In response to these oil market realities, a pure market economist might contend 

that high oil prices will spur conservation and temper demand growth while encouraging investment in crude oil production. The result will be more supply and less 

demand and oil prices will fall signaling the end of the current cycle. At current 

prices, even development of the least conventional sources of liquid hydrocarbon production (i.e., gas and coal to liquids and tar sand, shale and bituminous deposits) 

is affordable. In short, conventional oil gets a boost from the traditional investors 

and oil sands, bitumen, oil shale, biodiesel, and other alternatives get a boost from 

the entrepreneurs. The current boom cycle comes to an end, the market equilibrates 

and prices fall. 

The mean reversion, market equilibrates view of today’s prices, however, does not 

yield an accurate characterization of where we go from here. Given that many of 

the factors that have led to $100 oil are structural ones, the amount of investment 

in new production of oil (or alternatives) and the demand restraint required to re 

equilibrate the market is substantial. Moreover, the players in the market, whether 

24 

8The recent signing of the 2007 Energy bill into law already signals more government intervention in the U.S. oil sector as it raises CAF ́ E (fuel economy) standards to 35 mpg by 2020 

and calls for 36 billion gallons of alternative fuels used in transportation fuels by 2022. 

they are national governments or private companies, are either changing altogether 

or developing new attitudes towards oil. 

Governments May Not Think So... and May Intervene in Markets 

In today’s market, oil supply disruptions are perceived to be more likely and more 

difficult to counteract. The recent strength in oil prices is, in part, because they 

have internalized the energy security concerns highlighted by the War in Iraq and 

terrorist attacks in and outside of the Middle East. Civil unrest in Nigeria, the 

standoff between the U.S. and Iran over nuclear weapons, and tensions between the 

Bush Administration and President Chavez of Venezuela underscore historical concerns about the security of supplies. In a well-supplied market, the consequences of 

a supply disruption can be managed through alternative supplies. In a capacity constrained market, however, every disruption has more severe consequences. These 

energy security concerns have moved energy higher on the public policy agenda in 

many countries. 

Higher oil prices have also lent perhaps undeserved credence to the claim that 

the volume of conventional oil production is at or very close to its peak. Pinpointing 

the year in which conventional oil production peaks or plateaus is unnecessary and 

far too contentious an exercise. What matters is that alternative liquid hydrocarbons 

like syncrudes from oil sands or bitumen and alternative fuels from biomass and 

agricultural crops will increasingly become part of the liquid fuel mix over the next 

few decades. The expansion of ethanol in the U.S. gasoline pool is an early and instructive example of the trend towards greater volumes of non-traditional hydrocarbons or non-hydrocarbons in the petroleum product pool. This trend will become 

more widespread. 

Regardless of the veracity of the ‘‘Peak Oil’’ argument, it has raised a red flag 

about the longterm supply of conventional oil and its adequacy for meeting oil demand. This has led the major stakeholders, including producers, consumers and government regulators to rethink the alternatives. In some countries, especially those 

without oil production, the government response to these concerns is likely to be 

more conservation. Regulations that improve efficiency and reduce consumption 

seem almost inevitable in some countries. Likewise, countries with dwindling oil 

production, which are becoming bigger and bigger net importers are pursuing policies to secure foreign supplies. Meanwhile, all net oil-importing countries are considering changes to their energy mix if their resource endowments allow. 

Finally there is the environment. Efforts to reduce emissions and clean up fuels, 

especially transportation fuels, will continue around the world. But behind those efforts is a far bigger environmental issue for the global oil sector: reducing greenhouse gas (GHG) emissions. 

In sum, the continued dominance of the ‘‘market’’ as the organizing principle of 

global oil is under attack by two overriding concerns: energy security and the environment. One could argue that these challenges have always existed, but it seems 

clear that the absence of ‘‘spare’’ capacity in production and refining has dramatically underscored the energy security issue while growing consensus on climate 

change has transformed the environment issue. With this in mind, market regulation in the petroleum sector is far more likely in the next two decades than in the 

last two.8

Where Do We Go from Here 

It is difficult to look very far out when examining the structural factors shaping 

oil prices today, but one can say something about the next 5 years or so with some 

confidence. As described earlier, the two most important structural factors contributing to high oil prices are tight refining capacity and limited spare crude production capacity. But investment is underway and in the medium term those problems 

will ease. *Charts E and F are projections of Charts B and C presented earlier. 

Based on ESAI’s analysis of global expansion of refining capacity and production capacity, both improve. The refining capacity projection indicates that the global utilization rate should fall below 95 percent. This is still a high number, but more consistent with the 1990s when oil prices were lower. The production capacity projection is more speculative because it encompasses many countries with declining oil 

fields and a handful of countries with expanding production. All of the spare capacity is held in OPEC and the view in Chart F is probably optimistic in magnitude 

but accurate in direction. 

25 

Beyond 2013, the picture is much more difficult to draw because the structural 

tightness in the global supply chain never disappears. It just improves and deteriorates depending on the ebb and flow of investment and demand. With that in mind 

it is difficult to imagine a return to $30 crude oil. At the same time, $90-100 crude 

oil will be hard to sustain. In short, market equilibrium is much more loosely defined and probably refers to a price range of $50-$80 with more potential to break 

above that range than below that range. 

Conclusions 

The last two decades of deregulation and reliance on market forces as the defining 

principle of the oil markets has run its course and, on the margin, regulation is 

moving back into the oil patch. The confluence of high prices, limited upstream and 

downstream spare capacity, instability in producing countries and concerns over climate change are encouraging coalitions that endorse change in energy policies. 

Whether it is in the name of environmentalism, national security, resource stewardship or mercantilism, many different political and economic interests are looking for 

a change to the regulatory status quo. Slowly their efforts will gain ground in countries all over the world. 

In the meantime, the global oil market remains perched on a three-legged stool 

of high oil prices, a weak dollar and huge flows of petrodollars into investments 

around the world. This stool has been fairly steady over the last several months, 

but it does not represent a status quo that will satisfy most governments. The high 

oil prices, in particular, are a direct concern for consuming governments and an indirect concern for producing governments if they see consumers turning to conservation and alternatives. The weak dollar is a concern for U.S. consumers and must 

make oil producers worry about inflation in their economies. Consuming governments will be compelled to take action to protect their economies. Producing governments will invest to broaden their oil price windfall and, in the process, perhaps 

take the edge off high prices. But it will take time to effectively slow demand growth 

and increase supply growth. Moreover, slower demand and faster supply will not be 

smooth and not commensurate, especially as governments take a bigger role in markets. So the stool may rock, but remain upright for some time. Oil prices will eventually moderate (and the stool will topple), but prices will remain volatile and unpredictable as the steps taken by governments unfold. 

The CHAIRMAN. Thank you very much. 

Mr. Book. 

STATEMENT OF KEVIN BOOK, SENIOR ANALYST AND SENIOR 

VICE PRESIDENT, FBR CAPITAL MARKETS CORPORATION, 

ARLINGTON, VA 

Mr. BOOK. Thank you, Chairman Bingaman, Ranking Member 

Domenici and distinguished members of this committee. Thank you 

especially given what I do for a living is I analyze energy policy in 

the geopolitics of energy for institutional investors. So spending 

this time with you is a little bit like spending the morning with 

Elvis. 

I’m very, very grateful to be here. Part of this discussion as well 

because I think you’ve done wonderful things on a bipartisan way 

to engage corporations and citizens in what has to be discussed 

which is how energy works and why it’s important for energy and 

environmental security to know these things. So I’m very grateful 

for all of those things. 

At the core of this discussion the global economies of emerging 

nations have entered their energy hungry adolescence. The policy 

decisions that will have 30 to 50 year implications amid rapid 

change will require public and private sector leaders to keep their 

heads. If history is any guide, it won’t be easy. 

Since there’s a lot of the same things probably that are going to 

be said in our testimonies, I’m going to go a little off script. But 

I want to make a point that every one of the issues that has been 

cited by financial economists, Wall Street types, academics, have 

26 

been true as a result of what Ms. Emerson said just now and what 

I’ll suspect you’ll hear again and from others. They include insufficient working inventories, refinery capacity constraints, the growth 

of China, geopolitical risk, cost inflation and depreciation of the 

dollar and the notion that non-commercial buyers are driving 

prices up is also partially true today, I believe. Particularly if you 

believe that investors are seeking value retentive refuge from the 

falling U.S. dollar. 

But what I would encourage is the thought that this phenomenon 

certainly won’t be true forever. It may not even be true for long. 

Since you’ve kindly offered to put my written testimony in the 

record, I want to just hit on a few points that are incremental to 

what has already been said. 

First, an institutional investor, these are the people that are my 

firm’s clients. They manage other people’s money professionally. 

Simply put those people will fire their money managers when they 

lose them money. This pressure applies equally to sovereign funds 

and hedge funds. 

So CalPERS announced their plans to invest billions in commodities and commentators said well, if they’re doing it and they’re 

very conservative of the pension fund they must be by charter, and 

every investor must be doing it. I think that’s partially true. Investors of all strides are indeed diversifying into commodities. Some 

are buying. Some are selling. Some who are buying today may be 

selling tomorrow. If the funds flow into commodities is in fact elevating oil futures and accumulating evidence of a slow down in oil 

consumer nations could provoke a sell off as conservative investors 

close their positions and aggressive investors sell short. 

Second, I want to draw a distinction between markets and mobs. 

Markets price value and emotions move mobs. Markets tend to reflect disagreement over price where as mobs reflect uniformity of 

opinion. In market bubbles mobs of otherwise rational actors may 

ignore readily available data that might have discouraged their behaviors had they not been blinded by fear, greed, or what 19th century author Charles MacKay, Extraordinarily Popular Delusion 

and the Madness of Crowds. 

It is not obvious to me that oil markets are over saturated. The 

aggregate value of daily oil consumption is about $7.5 billion. If 

every barrel for the next 8 years of future delivery were contracted 

at today’s prices which is a hypothetical extreme and not a rational 

case, just to make the point. The volumes could absorb about $20 

to $25 trillion. 

As our first witness noted open interest in oil recently reached 

about 2.8 million contracts. That’s about $280 billion at $100 dollars per barrel. That is a significant amount of money in its own 

right, but only about 1 percent of the theoretical market size. 

This is also not the only place for speculative money to go. Investors buy stocks for tomorrow’s cash-flows. They buy commodities 

for tomorrow’s scarcity. 

Too many dollars chasing too few barrels can be inflationary in 

the short term. In the medium term, however, non-commercial dollars provide working capital, as you know, to lower the cost of insuring future supply. In the long run premium signal even higher 

cost projects may be rewarded. 

27 

This year WTI futures prices have risen about 10 percent. With 

share prices of the three largest U.S. oil companies have fallen 

about 9 percent. As companies respond to these price signals those 

investments flows may shift. 

Futures prices cannot trade ahead of distraction costs forever. 

The price of oil is driven by speculation. The economies are slowing 

as we’re seeing. Eventually one of two things will dispel the mob. 

Either oil will fill up storage facilities and buyers will be physically 

unable to take delivery. Or new capacity will show up to take advantage of price premiums. 

Just a couple comments on oil and I’ll try to stick as close as possible to the time as well. Dramatic policy shifts and tax hikes can 

have self-defeating implications in a world where you’re effectively 

transitioning. I think that is the vision of this committee. I think 

it’s a good vision. 

But let’s look at what’s happening right now. The market is telling investors there’s a high price because of scarcity. Some of the 

marketers suggesting, and I don’t think they’re right, that countries like this one, industrialized economies, can’t conserve, won’t 

balance energy through environmental stewardship and don’t have 

the technology to produce alternative fuels cheaply. 

Others are suggesting that the production oil has peaked. I think 

that twice during the last 6 months, you know, you found big finds 

off the Brazilian coast. Currently high prices encourage new technologies. Part of oil companies will have to make those investments 

and operate those technologies for long periods of time. 

When you start to get into the production process, you start to 

find things with new technologies. Oil production can become very 

sticky because if you’re going to invest your own company, you 

don’t necessarily have the option to stop producing. Your board is 

expecting you to pay off the debt and fund future operations. So 

volumes may show up even if the price starts to soften. 

The circumstance of peak access is not a fundamental either. It’s political. The majors are coming out. Last month $3.7 billion were 

bid for drilling rights in the Gulf of Mexico. 

In this context you have to think that restricting where the U.S. 

has oil will only transfer wealth and market power to OPEC and 

this to my last point. OPEC can be, right now you can say it’s a 

little bit more of an effective cartel. Because at $100 a barrel 

there’s no reason for the weakest economies to blow through their 

quotas and defect to fund their cash-flows. 

That doesn’t mean, however, that protection isn’t the right answer. These countries do control 80 percent of the world’s reserves. 

They may not be enthusiastic about inviting western companies 

into their production bases, but they are enthusiastic about potentially investing their money in the downstream here in this country. Because they have very cheap oil and they can make more 

money if they can turn that oil into gasoline and sell it into our 

hungry market. 

So I would caution against the protectionist response. I’d also 

just close with the notion that we are probably reaching a peak appetite for oil. As we get there we will diffuse new cars into the vehicle fleet will be more efficient. We will eventually get to flex fuel 

or more flexible fuel vehicles. 

28 

It’s a lot of investment. It’s a lot of time. But while we get there, 

flexibility implies a choice in policies that encourage petroleum investment will help keep that choice open hence the cautious response to the idea of raising taxes on the companies that produce 

oil here at home. 

I’ve gone fairly off script, but I’m here for any questions. I look 

forward to them at the appropriate time. Thank you. 

[The prepared statement of Mr. Book follows:] 

PREPARED STATEMENT OF KEVIN BOOK, FBR CAPITAL MARKETS CORPORATION, 

ARLINGTON, VA 

Chairman Bingaman, Ranking Member Domenici and distinguished Members of 

this Committee, thank you for the privilege of appearing before you today. The 

views I will present this morning are my own and do not necessarily represent those 

of my employer. 

I would like to begin by offering my admiration for the comity and caution this 

Committee has demonstrated in addressing the energy and environmental security 

challenges facing the nation. Your efforts have already engaged corporations and 

private citizens alike in a necessary national discussion regarding the sources and 

uses of our natural resources. All around the globe, emerging nations are entering 

into their energy-hungry adolescence and the dislocations wrought by this paradigm 

shift will require public and private sector leaders to keep their heads. If history 

is any guide, it won’t be easy. 

During the last five years, the world’s top energy economists have offered a disarmingly variable sequence of explanations for the run in crude oil prices. At the 

beginning of the decade, market watchers counted days of demand cover, a measure 

of whether working inventories contained sufficient oil to meet expected demand. 

Subsequently, many of the same experts linked escalating prices to refining capacity 

constraints, the growth of wealth in China, geopolitical risks in the Middle East and 

Nigeria, cost inflation and, most recently, the depreciation of the dollar relative to 

other currencies. Each of these phenomena has correlated to, and sometimes predicted, oil prices. But none of these explanations has proven consistently useful 

throughout the decade or when back-tested against earlier data. 

The same might be said for the notion that non-commercial buyers of forward and 

futures contracts are driving up oil prices. This may be partially true today, and 

it may even be somewhat price-predictive to assess the flow of investor wealth into 

commodities, particularly if one believes that institutional investors may be seeking 

a value-retentive refuge from the falling U.S. dollar. But this phenomenon certainly 

won’t be true forever. It may not even be true for long. My comments regarding investor motivations, market dynamics and oil production are intended to suggest that 

an optimal policy response should not ignore the historical tendency of the law of 

supply and demand to govern long-term oil market outcomes. 

AN OVERVIEW OF INSTITUTIONAL INVESTORS’ INCENTIVES

Generally speaking, an ‘‘institutional’’ investor manages other people’s money professionally. One or several layers of management expertise can lie between primary 

investors and markets. Institutional investors themselves compete in the market for 

asset management services. Widely variable charters constrain the asset classes 

that different investment funds may hold and the strategies that institutional investors may employ, but all asset managers share a common trait: they are paid to retain, and ideally to augment, their clients’ wealth. Simply put, investors fire managers who lose their money. 

On February 28, 2008, CalPERS, the California pension fund, announced plans 

to invest as much as $7.2 billion through calendar year 2010 in commodities. At the 

upper bound, this could represent a little less than 3% of the portfolio, a meaningful 

commitment to commodities as an asset class. This was neither unexpected nor 

unheralded. The first exchange-traded fund (ETF) created to track crude oil contract 

prices began trading on the London Stock Exchange in July 2005. The first U.S. oil 

ETF began trading on the American Mercantile Exchange in April 2006. Oil ETFs 

typically buy and sell oil futures to enable investors who might not buy commodities 

to replicate the performance of oil markets. Oil ETFs largely resemble an earlier 

vintage of ETF, S&P 500 ‘‘index funds’’ that buy and sell S&P component equities. 

At the time of the CalPERS announcement, several market commentators extrapolated its implications, reasoning that, if institutions as conservative as pension 

29 

funds were buying oil, then everyone else must be, too. I would respectfully submit 

an alternative thesis. Investors of all stripes may be diversifying into commodities 

markets, but they are not all buying. Some are likely to be selling, and many of 

the investors who are buying today might well be selling tomorrow, depending on 

their risk tolerances. 

Hedge fund managers typically earn fixed management fees but the bulk of their 

compensation usually derives from percentages of earned profits. Because hedge 

funds may hold heavily concentrated positions or illiquid investments, it can take 

fund managers days, weeks or months to gracefully unravel their positions without 

destroying fund value. As a result, most hedge fund charters limit the opportunities 

for investors to ‘‘redeem’’ invested capital to narrow, periodic windows. This can encourage hedge fund managers to pursue higher-risk strategies, including investments that may result in short-term losses. But the wealthy individuals and institutions who buy into hedge funds pay premiums in return for high performance. These 

clients can grow impatient and vote with their wallets if managers deliver sustained 

losses. Managers of funds with smaller cash holdings could conceivably exert downward pressure on oil prices by closing long positions in a hurry to service a spate 

of redemptions. 

Sovereign funds exist to diversify national wealth away from its source. This is 

a matter of particular concern for oil-producing nations and Asian export economies. 

Sovereign fund managers usually have a single client, eliminating the competitive 

pressures for performance that can force quick sales of securities or, for that matter, 

discourage risky bets. Historic wealth transfers from largely Western, consumer nations to the largely Eastern producer nations that supply them have provoked timely calls for best practices and transparency by the IMF and OECD. Transparency 

is warranted, but protectionism is not. If fund managers are ‘‘diversifying’’ producer 

nations’ sovereign wealth into oil futures, this might suggest similar economic circumstances to those that often motivate corporate stock repurchases: managers may 

not see any better way to safely invest the money. If this is true, new barriers— 

including bills like the ‘‘No Oil Producing and Exporting Cartels’’ (NOPEC) Act— 

to U.S. investment might further encourage dollar flight to commodity futures. 

At the same time, there may be two offsetting forces influencing sovereign investment in oil futures. Sovereign fund managers must answer to their clients, after all, 

and leaders of Gulf Cooperation Council nations have made known their concerns 

that the declining dollar has eroded their largely dollar-linked national wealth. 

Since oil trades in U.S. dollars, fund managers have an obvious motivation to hedge. 

On the other hand, these same clients are also best positioned to know when oil 

demand may be slowing, and they might well advise their fund managers to lighten 

up on commodities ahead of a slowdown, even if it means downward pressure on 

oil prices. This could conceivably occur if EU-27 economic growth began to slow as 

a United States slowdown continues, as oil could sell off at the same time that the 

U.S. dollar appreciated relative to the Euro. 

If funds flowing into commodities are indeed elevating oil futures, then accumulating evidence of a slowdown within the world’s biggest oil-consuming economies 

could provoke an equal and opposite reaction as conservative investors close their 

positions and aggressive investors sell short. 

MARKETS, PRICES AND MOBS

The question remains unclear, in my mind, whether the oil markets are vulnerable to manipulation by speculators, or whether speculators are vulnerable to manipulation by the oil markets. 

There is a lot of difference between a market and a mob. Markets are driven by 

the value of a good or service; mobs are driven by human emotions. Markets reflect 

disagreement over price; mobs typically reflect uniformity of opinion. Retrospective 

analyses of market bubbles often reveal how many otherwise rational actors caught 

up in the mob ignored readily available data that might have discouraged their behaviors, had they not been blinded by fear, greed or what 19th Century author 

Charles Mackay termed ‘‘extraordinary popular delusions and the madness of 

crowds’’. 

Markets set prices for buyers and sellers, but market prices also inform those 

buyers and sellers by summarizing the collective decisions of market participants 

into a number and a direction. Numbers and directions are objective truths, but 

their interpretation can be very subjective. For example, the market could be suggesting that this—and other—nations lack the willpower to adhere to conservation 

plans, the flexibility to rebalance energy needs with environmental stewardship or 

the technological wherewithal to produce economically-viable alternative fuels. 

30 

Many market participants appear to believe with great certainty that high prices 

signify peak oil production. This seems particularly surprising now that, twice during the last six months, oil companies have identified possible ‘‘super-giant’’ oil 

fields off the Brazilian coast, underneath the salt layer and well within the reach 

of modern technology. It might seem safer to assume that the moment when mankind will have exhausted 50% of the oil molecules in the Earth’s crust is still a long 

way off, but that’s not what the futures market may have been thinking in March. 

A March 16, 2008 Financial Times story entitled, ‘‘Investors bet on $100 a barrel 

until 2016’’ was the first of many media reports I read that attributed the close of 

long-dated crude futures as a shift in sentiment towards enduring scarcity. Indeed 

there were bets out to 2016 on $100 oil, but not a lot of them. In fact, only 108 

December 2016 WTI contracts traded on March 14, 2008 (the date referenced by the 

article) as compared to 293,217 front-month contracts. 

The oil market isn’t the only place for speculative money to go, nor are oil markets obviously oversaturated. Crude oil is the most widely traded commodity in the 

world. Daily oil consumption of about 86 million barrels has an aggregate value of 

approximately $7.5 billion, discounting for quality. Commodities exchanges trade 

contracts for physical deliveries eight years in the future. In theory, if every barrel 

for the next eight years of future delivery were contracted at today’s price and volume assumptions, those contracts could absorb about $20–25 trillion. Open interest 

in light sweet crude oil contracts is approximately 2.5 million contracts. Each contract represents 1,000 barrels, making open interest worth $250 billion at $100 per 

barrel. $250 billion is a staggering sum in its own right, but only about 1% of the 

theoretical maximum market size, and a rounding error in contrast to the global notional value of derivative instruments of all kinds, which the Bank of International 

Settlements estimated in June 2007 to be worth more than $500 trillion. 

Capital markets and commodities markets play different roles in wealth creation. 

The value of equity securities derives from investor expectations that today’s investments will deliver tomorrow’s cash flows. When equity values appreciate, corporations can sell treasury stock or issue a follow-on stock offering to capitalize investment or retire expensive debts. The value of commodities usually derives from scarcity, at least in the short-term. The short-term effects of a growing volume of dollars 

chasing a currently fixed number of barrels can be inflationary in cases where new 

investment grows meaningfully relative to the market size. For the intermediate 

term, however, dollars spent by non-commercial bidders provide working capital 

that doesn’t have to come from either producers or commercial users, lowering the 

transactional and financial costs of ensuring adequate future supply. In the long 

run, dollars that rush into the oil markets will play a very important role. The premiums above production cost visible in today’s oil market will ultimately have the 

effect of encouraging future production by signaling producers that even higherpriced projects like tar sands, tertiary oil recovery and alternative fuels may be rewarded. 

As companies begin to position themselves to respond to price signals, investment 

flows may shift. This year, WTI futures prices have risen about 10%, while the 

share prices of the three largest U.S. integrated oil companies, ChevronTexaco, 

ConocoPhillips and ExxonMobil have fallen about 9% on a market-cap-weighted average basis during the comparable period. This suggests at a very cursory level that 

investors would rather hold oil itself than the companies that produce it (it is cursory to say this because the same investors don’t always play equities and commodities markets). A shift in investment flows into oil companies and away from commodities may have predictive value as well as a technical effect. Historical oil prices 

have normalized in response to demand abatement, but also as a result of technology improvements and the economic decisions made by nations that control access to resources. 

Investors have limited visibility into the true state of global oil production. Divining the state of affairs requires constant attention to the reserves and production 

data reported publicly by governments, investor-owned companies and some stateowned firms as well as the refiners who ultimately purchase oil for commercial use. 

Investors may also consider proxies for consumption, like economic growth, and 

value chain constraints, like freight and shipping indices, as well as a range of 

third-party, proprietary sources that investigate everything from the comings and 

goings of tankers to orders for specialized capital equipment used for oil production. 

Some investors may be overwhelmed by the sheer volume of data to the point where 

the marginal benefit of incremental analysis exceeds the marginal benefit (or cost) 

of making a bad investment. Ironically, other investors may rely in the absence of 

empirical evidence on the signals generated by financial markets for futures contracts, in which case the endless trumpeting of rising WTI contract prices may create a ‘‘feedback loop’’ that seems to suggest enduring scarcity. 

31 

Futures contracts cannot trade ahead of extraction cost forever. If the price of oil 

is, as OPEC suggests, being driven by speculation, then at least one of two things 

might happen to dispel the mob: either oil will fill up storage facilities and buyers 

will be physically unable to take delivery, or new capacity (or alternatives) will show 

up on the market to take advantage of price premiums. 

PEAK OIL, PEAK ACCESS OR PEAK APPETITE?

The price of oil goes up—and down—but it doesn’t always move smoothly. Commodities markets can be ‘‘sticky’’—that is, supply may not immediately respond to 

price. The following, very brief description of the exploration, production and refining sectors may help illustrate some of the reasons. 

First, let’s be clear about what we mean by ‘‘oil’’. Geological petroleum deposits 

take many forms. The word ‘‘oil’’ can apply to a wide range of compounds of differing 

densities, viscosities and purities. The petroleum industry classifies oils that contain 

more natural gasoline and lower-density molecules as ‘‘light’’ and oils that contain 

lower levels of sulfur and other impurities as ‘‘sweet’’. Ultimately, the value of oil 

depends on the processing capabilities of the refiners—the commercial customers— 

who buy it. Refiners consider oils that are light and sweet to be ‘‘high quality’’ because they can be distilled into transportation fuels, chemicals and industrial products at lower fixed and variable costs than oils that are ‘‘heavy’’ and ‘‘sour’’. As global demand grows, oil companies are drilling deeper for oil and producing, on average, barrels that are heavier and sourer. Refiners’ corresponding investment in new 

and higher complexity refineries generates new market opportunities for exploration 

and production companies (or divisions) to look again at resources they once ignored. 

Oils of similar composition tend to be interchangeable in the short-term. In the 

intermediate term, refiners of higher-quality oils who want to use lower-quality oils 

must invest in new refining equipment capable of processing impurities. Operating 

these higher-complexity refineries requires more energy, resulting in increased perunit costs. However, the finished products that refiners make from oil—gasoline, 

diesel and jet fuel—are also commodities. Refiners must accept the market price offered for the products they produce, because any attempts to recapture additional 

costs by charging a higher price are likely to be undercut by competitors who 

produce fuel at lower marginal cost. As a result, the global refining industry as a 

whole typically prefers to pay less for lower-quality grades. Price relationships between oil grades tend to normalize over time because refiners will eventually invest 

in highercomplexity equipment to take advantage of sustained discounts for heavier 

or sourer oils. Similarly, greater demand for low-quality oils can bid them up relative to high-quality oils and diminish or stabilize demand for high-quality oils. 

Thanks to high prices, oil companies are willing to consider new technologies. Incremental technology improvements are expensive to deploy. Oil companies will be 

most willing to put capital at risk when they believe robust demand will reward 

their investments. Incremental deployments of new technologies often bring rewards 

in the form of process improvements as employees climb their ‘‘learning curves’’. In 

subsequent deployments, oil companies can also take advantage of scale economies 

by standardizing operations around new technologies. On the other hand, oil production doesn’t easily switch on and off, for a variety of practical and economic reasons. 

Petroleum production takes time; seven to ten years typically lie between the corporate decision to proceed and delivery of oil to the market. Because executives at 

investor-owned companies are accountable to shareholders, even if the price of oil 

falls between the time company management puts money into a project and the 

time production begins, oil companies may need to operate at loss in order to generate enough cash to pay back their up-front investments and fund future efforts. 

Thanks to technology, it’s easier to find oil. The days when a lone wildcatter with 

a dowsing rod and big dreams could uncover a gusher of Texas Tea with a hand 

drill ended decades ago. That’s because most of the readily accessible large oilfields 

discoverable through yesterday’s technologies are already in production. But this 

doesn’t mean that the world’s oil supply has peaked. The Earth is a big place, and 

oil deposits reside at varying depths throughout the Earth’s crust all the world over. 

New seismic and electromagnetic technologies and advanced computer modeling 

make it possible for oil companies to identify significant new petroleum deposits in 

places where it had never been possible to look in the past, like underneath thousands of feet of rock or seawater. Drilling technologies are becoming superficially 

similar to endoscopic surgical techniques. In the not-too-distant future, producers 

may be able to access underground reservoirs by creating minimally intrusive surface holes and threading their drill-bits between rock formations. Oil companies are 

getting more out of every well, too. Enhanced oil recovery technologies using water 

32 

and carbon dioxide are enabling North American production volumes that exceed 

original estimates by as much as 30% to 45%. 

Are we on the other side of ‘‘peak access’’ to oil reserves? Investor-owned companies face increasing barriers to drilling overseas as oil-rich sovereigns renegotiate, 

expropriate and nationalize their petroleum sectors to capture greater value from 

high prices. High prices may also have made OPEC a more effective cartel. At $100 

per barrel, OPEC nations collectively generate about $3 billion each day. When 

prices were $10 to $15 per barrel, the poorest oil exporters sometimes exceeded their 

assigned quotas to keep national treasuries solvent. Today, even weaker producer 

economies can afford to hold the line on supply. Greater wealth means that the 

state-owned oil companies that control more than 80% of global reserves can afford 

their own advanced oilfield technologies and have fewer incentives to grant favorable concessions to investor-owned oil companies. A telling sign that the game is 

changing arrived last month, when oil companies bid a record $3.7 billion for offshore drilling rights in the Gulf of Mexico. In this context, restricting drilling where 

the U.S. has oil—including the Arctic National Wildlife Refuge and the Eastern Gulf 

of Mexico—will only transfer wealth and market power to OPEC. 

Once again, protectionism is the wrong answer. Petroleum refining is a tough 

business for the U.S. oil companies that must pay top dollar for raw materials on 

the global market but end up selling a commodity. The prospect of punitive taxation 

and escalating environmental expenditures may make investor-owned companies 

understandably leery of committing multiple billions of dollars towards the building 

and expansion of their refineries. Not every oil company may regard investment in 

U.S. energy infrastructure as a bad deal. For state-owned oil companies, a new or 

bigger U.S. refinery could improve the profits associated with production of lowerquality crudes by turning them into gasoline to capture what has typically (but not 

always) been at a premium to their unrefined value. 

It may be that we are merely reaching our ‘‘peak appetite’’ for oil. Energy crises 

provoke transformational efficiency gains, even though they are expensive and take 

a long time to play out. Assessing oil production limits requires an examination of 

the vehicles that use petroleum-derived fuels, too. Today’s cars, trucks and things 

that go are already quite flexible and will become more so. Forecasts made by the 

EIA, IEA and industry groups leave little doubt that many of the vehicles on the 

road today are taking growing advantage of fuels from non-oil sources that are similar in composition and performance to petroleum distillates. Likewise, tomorrow’s 

transportation fleet is likely to employ liquid fuels of any origin much more efficiently than today’s fleet. Technologies like hybrid petroleum-electric propulsion systems are now maturing. High prices are already provoking commercial aviation companies to look for low-cost, high-yield design changes that minimize energy lost to 

friction, like the wing ‘‘tips’’ frequently installed on commercial airlines. It seems 

likely that a conservation response is already underway and I believe the U.S. government is right to encourage it. 

New taxes could have self-defeating implications in the meantime. Replacing the 

230 million passenger vehicles on U.S. roads will take 15 to 20 years if we start 

today. Electric cars may require, among other things, investment towards a more 

reliable power grid. Likewise, diffusion of flexible fuel vehicles and E85 dispensers 

could require more than $50 billion in incremental spending and will rely on economic, large-scale production of cellulosic biofuels. A ‘‘flexible’’ vehicle implies a 

choice, and policies that encourage petroleum investment will keep that choice open, 

even as policies this Committee has enacted pave the road to future fuels. Corporate 

leaders of for-profit companies must balance expected returns from 30-year projects 

against the risks that federal budgets can change annually, congressional polarities 

can reverse biennially and new regulators might reinterpret existing law every four 

or eight years. Dramatic policy shifts and tax hikes could make it harder, not easier, 

for oil companies to transition to future fuels. 

AN AFTERTHOUGHT REGARDING THE U.S. RELATIONSHIP WITH PETROLEUM

Addiction is the wrong metaphor. We didn’t start refining oil by accident. Oil continues to fuel 97% of the world’s vehicles because generations of engineers, corporate 

leaders and policy planners selected it on the basis of its suitability. Oil is energydense, readily transportable and plentiful relative to alternatives, even despite the 

high prices of the moment. Allow me to suggest a different metaphor. For the foreseeable future, petroleum will continue to fuel industrialized societies the same way 

oxygen nourishes the body. Two obvious conclusions emerge. 

• First, increasingly prosperous, growing populations will require more oil, not 

less. 

33 

• Second, a man who is short of breath is not addicted to oxygen; he may just 

need to get in shape. We will need to use oil more efficiently. 

This concludes my prepared testimony. I will look forward to responding to any 

questions the Committee might have at the appropriate time. 

The CHAIRMAN. Thank you very much. 

Mr. Burkhard. 

STATEMENT OF JAMES BURKHARD, MANAGING DIRECTOR, 

CAMBRIDGE ENERGY RESEARCH ASSOCIATES, CAMBRIDGE, 

MA 

Mr. BURKHARD. Thank you, Mr. Chairman. It is an honor to address the committee on the issue of the influence of non-commercials on the price of oil. 

First of all, who are these non-commercial investors? They are 

more than just short-term, speculative, traders. They represent a 

broad spectrum of investors ranging from managers of pension 

funds and university endowments and other institutional investors. 

They allocate investment capital based upon a view of the world’s 

need for oil and other commodities. 

So why have oil prices been rising? The growing role of non-commercial investors can accentuate a given price trend. But the primary reasons why oil prices in recent years have been rising are 

rooted in several factors. 

One is the fundamentals of demand and supply, which we’ve 

heard about. Geopolitical risks which do have a real impact. Skyrocketing oil industry costs. More recently we’ve seen the decline 

in the value of the dollar play a more significant role, particularly 

since the credit crisis first erupted last summer and energy and 

other commodities got caught up in the upheaval of the global economy. 

That to be sure the balance between demand and supply is integral to oil price formation and will remain so. But there are, what 

we call, new fundamentals that are behind the momentum that 

push oil prices to their recent record high levels. These new fundamentals are one, new cost structures and two, global financial 

dynamics. 

First, new cost structures. As oil prices have risen, so has demand for the people and equipment that are needed to find, develop and produce oil. Major shortages of equipment and personnel 

have dramatically raised the cost of finding and developing oil all 

around the world. The latest IHS CERA upstream capital cost 

index, which is a sort of consumer price index for the oil industry, 

shows that the cost of developing oil fields has doubled in the last 

3 years. In addition, increasingly heavy fiscal terms on oil investments and in the form of higher taxes and greater state participation mean that much higher oil prices are needed to support development of new supplies. 

The second new fundamental is what we refer to as global financial dynamics. The oil price has long reflected major trends in the 

economy and geopolitics. For example in 1998 when the oil price 

went down to $10 that was largely a reflection of the fallout from 

the East Asian financial crisis. 

Today two major trends are the decline of the dollar and the rising economic clout of regions outside of the United States. In the 

34 

1The figure of 350 percent represents the increase in open interest in NYMEX crude oil contracts, which is a proxy for levels of trading activity. Open interest is defined by the US Commodity Futures Trading Commission as ‘‘the total number of futures contracts long or short in 

a delivery month or market that has been entered into and not yet liquidated by an offsetting 

transaction or fulfilled by delivery.’’ 

past half year in particular, lower interest rates in this country in 

anticipation of further cuts in interest rates has pushed the dollar 

lower. Amid great turbulence and credit and other financial markets the influence of the weak dollar on the oil market has grown. 

Oil has become what we refer to as the new gold. A financial 

asset in which investors seek refuge as inflation rises and the dollar weakens. That key element of the oil as the new gold story is 

the expectation that demand for oil will continue to grow and thus 

be able to hold its value despite the weak dollar and rising inflation. To degree an expectation of a strong oil price environment is 

a bet on the future of China, India and other high growth markets 

around the world. 

Since the beginning of last year, eight of the ten largest oil markets in the world have seen their currencies appreciate significantly against the dollar. When the currency appreciates against 

the dollar it diminishes the impact of an increase in the dollar 

price of oil for that market. This helps to sustain oil demand 

growth outside the United States. 

If economic and oil demand growth remain vibrant outside the 

United States and the dollar continues to weaken then financial 

dynamics are likely to drive oil prices higher. In addition the political and man power difficulties that are currently constraining oil 

supply growth will not disappear overnight. The desire for higher 

living standards in China, India and other emerging markets will 

remain as strong as it was in Europe, Japan and the United States 

in post World War II period. Higher living standards mean longer 

life expectancy, lower infant mortality and higher energy consumption. 

This year just as economic worries began to mount oil prices touched a new high of around $110 per barrel. Although oil prices 

are just one factor that affects the global economy, they are a significant one. Because the world economy was able to take $70 oil 

in stride does not mean that it can easily absorb $100 or higher. 

Oil prices are fluctuating in line with the latest economic signals. 

This will continue until a clearer view of economic growth materializes. But one factor is clear. The price of oil will reflect major 

swings in the value of the dollar both up and down. Thank you. 

[The prepared statement of Mr. Burkhard follows:] 

PREPARED STATEMENT OF JAMES BURKHARD, MANAGING DIRECTOR, CAMBRIDGE

ENERGY RESEARCH ASSOCIATES, CAMBRIDGE, MA 

It is an honor to address this Committee on the relationship between oil prices 

and the influence of noncommercial institutional investors, sometimes referred to as 

market speculators. Trading in futures markets establishes the reference price for 

nearly all crude oil sold in the world. Crude oil futures trading activity on the New 

York Mercantile Exchange—the largest in the world—is currently about 350 percent 

higher than in 2002.1 Noncommercial investors have contributed to this increase. 

Growth in trading activity is coincident with a rise in oil prices from $26 per barrel 

in 2002 to more than $100 in early 2008. The concurrence of these two trends has 

raised the question about the level of influence that noncommercial investors have 

in oil price determination. 

35 

2 CalPERS February 19, 2008 press release. 

What has been driving oil prices upward? It is primarily the fundamentals of demand and supply, geopolitical risks and rising industry costs. The decline in the 

value of the dollar has also played a role, particularly in the past six months. But 

with noncommercial investors playing a bigger role, the direction of a given price 

trend can be accentuated. And since the credit crisis first erupted last summer, energy and other commodities have become caught up in the turbulence of the global 

economy. 

NONCOMMERCIAL INVESTORS

The US Commodity Futures Trading Commission defines noncommercial or speculative investors as those who are not physically exposed to the commodity but trade 

‘‘with the objective of achieving profits through the successful anticipation of price 

movements.’’ This group of market participants includes more than just short-term 

speculative traders. It represents a broad spectrum of investors with different time 

frames and motivations such as mangers of pension funds, university endowments 

and other institutional investors. These investors increasingly view commodities and 

oil in particular as an asset class. They allocate investment capital based upon a 

view of the world’s need for oil and other commodities. For example, the California 

Public Employees Retirement System (CalPERS), the largest public pension fund in 

the United States, recently increased the amount it could invest in an asset class 

that includes commodities. This move is part of a ‘‘new strategy to provide a hedge 

against inflation while diversifying investments, thus mitigating losses during equity market downturns.’’2

Noncommercial investors are an essential part of a futures market. In the 1860s 

Chicago grain traders developed the first futures contract: an agreement to buy or 

sell a commodity at a future date. Farmers were able to offload price risk to speculative traders. In exchange for providing price certainty to the farmer, the trader had 

the opportunity to turn a profit—or a loss—from future price changes. This allocation of risk remains the foundation of today’s futures markets. 

Noncommercial investors can also provide another attribute of a well functioning 

futures market: liquidity. Liquidity refers to how quickly a counterparty can be 

found for a transaction. The current turbulence in credit markets illustrates the 

dangers that materialize when trading in a market becomes illiquid. Uncertainty 

and fear come to the fore, which exacerbates market turmoil. Oil futures markets 

are among the most liquid in the world—and have remained so despite the upheaval 

in credit markets. 

In a sufficiently liquid market, the number and value of trades is too large for 

speculators to unilaterally create and sustain a price trend, either up or down. The 

growing role of non-commercial investors can accentuate a given price trend, but the 

primary reasons for rising oil prices in recent years are rooted in the fundamentals 

of demand and supply, geopolitical risks, and rising industry costs. The decline in 

the value of the dollar has also played a role, particularly since the credit crisis first 

erupted last summer, when energy and other commodities became caught up in the 

upheaval in the global economy. To be sure, the balance between oil demand and 

supply is integral to oil price formation and will remain so. But ‘‘new fundamentals’’—new cost structures and global financial dynamics—are behind the momentum that pushed oil prices to record highs around $110 a barrel, ahead of the previous inflation-adjusted high of $103.59 set in April 1980. 

NEW COST STRUCTURES

In 2004 the price of oil (in nominal terms) averaged above $40 for the first time 

ever. This was sparked by extraordinary demand growth that reflected strong global 

economic expansion and a temporary surge in the use of oil to generate power in 

China. Further demand growth in 2005 reduced spare oil production capacity to just 

1 million barrels per day (mbd)—compared with 4 to 6 mbd in the 1990s. Amid the 

whittling away of spare capacity, political change and security worries in several 

major oil exporting countries fueled anxiety about the adequacy of oil supplies. With 

so little spare capacity, such fears drove oil prices higher. 

As oil prices rose, so did demand for the people and equipment needed to find, 

develop and produce oil. But nearly 20 years of low oil prices and industry consolidation meant ‘‘a missing generation’’—a generation that skipped entering the petroleum industry. As a result, major shortages of equipment and personnel dramatically raised the cost of developing an oil field whether in the Gulf of Mexico, West 

Africa or the Middle East. CERA and IHS have developed a series of indices to 

measure changes in cost—sort of a Consumer Price Index for the energy industry. 

36 

Costs to build power plants and oil refineries have surged higher. But the one most 

relevant to our discussion today is the latest IHS/CERA Upstream Capital Cost 

Index. This index shows a doubling of oil field costs over the last three years. In 

other words, companies have to budget twice as much today as they did three years 

ago. Adding to the cost pressure are increasingly heavy fiscal terms on oil investments in the form of higher taxes and greater state participation in oil projects. The 

net result is that much higher oil prices are needed to support development of new 

supplies. Some projects that in the past needed oil prices of $20 or $30 in order to 

move forward now need price levels that are double that amount—or even higher. 

It can take ten years or more to find, develop and begin production from a new 

oil field, particularly if it is large and complex. Long lead times and the severe upturn in costs have led to one of the most significant changes in the oil market: a 

steep increase in long term oil price expectations. For nearly two decades, until 

2004, expectations for long-term oil prices hovered around $18 to $25 per barrel. 

Since 2004 the price of a futures contract to buy or sell crude oil five years out has 

risen steadily. It topped $100 per barrel this year. Five years is considered longterm from an oil market perspective as opposed to the longer times that can be required to develop a new oil field. The sustained breakout of oil prices from a relatively narrow historical range along with global financial dynamics has fostered 

greater interest in oil among financial markets. 

GLOBAL FINANCIAL DYNAMICS

The oil price has long reflected major trends in the economy and geopolitics. Rising inflation, a rush to invest in commodities and worrisome tension between the 

United States and Iran drove oil above $100 per barrel in real terms in 1980. In 

1998 the price of oil collapsed largely because of the fallout from the Asian financial 

crisis. Today, two major trends that are reflected in the price of oil are the decline 

of the dollar and the rising economic clout of many regions outside the United 

States. 

Oil and the Dollar: The New Gold 

The effect of a declining dollar on the price of oil first became prominent in early 

2005. The dollar had fallen about 35 percent relative to the euro since 2002. OPEC 

generally imports more from Europe than the United States, so a weak dollar damages terms of trade from OPEC’s perspective. The falling dollar contributed to the 

lifting of OPEC’s implicit oil price objective, which altered market expectations 

about price and the balance between demand and supply. The price of oil was nearing $50 per barrel—a very high price at the time. 

In the past half year lower interest rates and anticipation of further cuts in interest rates pushed the dollar lower. Amid great turbulence in credit and other financial markets, the nature of the weak dollar’s influence on the oil market changed. 

Oil has become the ‘‘new gold’’—a financial asset in which investors seek refuge as 

inflation rises and the dollar weakens. This may seem counterintuitive at a time of 

weak oil demand in the United States, but today’s dynamics in the marketplace reveal oil’s increasingly cosmopolitan nature. The price of oil reflects not only demand 

and supply, but broader macroeconomic and geopolitical changes such as the growing influence of Asia, the Middle East, Russia and the Caspian countries. 

Strong economic growth outside the United States has not only supported growing 

oil demand but also propelled rising demand and prices for many commodities. In 

addition to energy, food prices are surging around the world. According to the International Monetary Fund. global prices for cereals—wheat, rice, corn (maize), and 

barley—increased 82 percent from 2000 to 2007. More than half of this increase has 

been in the past two years. Recent data from China show food prices pushing overall 

inflation to 8.7 percent—the highest level in more than a decade. 

A key element of the ‘‘oil as the new gold’’ story is the expectation that demand 

for oil will continue to grow, and thus be able to hold its value despite a weak dollar 

and rising inflation. To a degree, an expectation of a strong oil price is a bet on the 

future of China and India. The United States is the world’s largest oil consumer, 

but 75 percent of global demand is outside the United States. For example, since 

the beginning of 2007 eight of the ten largest oil markets in the world (excluding 

the United States and Saudi Arabia, whose currency is pegged to the dollar) have 

seen significant currency appreciation ranging from 9 percent (India) to 19 percent 

(Brazil). When a currency appreciates against the dollar, it diminishes the impact 

of an increase in the dollar price of oil in that market. Also, regulated prices of gasoline and diesel in some key markets means that consumers are not exposed to the 

full increase in the global market price of those products. This places pressure on 

government and company budgets, but if a given country enjoys strong economic 

growth it can withstand, at least for a time, rising oil prices. 

37 

OUTLOOK

If economic and oil demand growth remain vibrant in large markets around the 

world and the dollar continues to weaken, then financial dynamics could continue 

to drive oil prices higher. But oil’s role as a financial hedge does not mean that its 

price will rise continuously. Prior to the ascent in recent years, both gold and oil 

prices had been mired in long-term price slump. In the late 1990s, $100 oil—or even 

$80 oil—seemed preposterous. Today, $20 oil seems quaint. 

The political and manpower difficulties currently constraining oil supply growth 

will not disappear overnight. The desire for higher living standards in China, India, 

the Middle East, Russia and elsewhere will remain as strong as it was in Europe, 

Japan and the United States in the post World War II years. Higher living standards mean longer life expectancy, lower infant mortality—and higher energy consumption. 

But just when the future seems preordained in the oil market, the unexpected can 

unfold. It did in the decade following 1998, just as it had several times since 1970. 

This year will be a stiff test for the new oil price era that dawned on the world several years ago. Economic growth is the single most important determinant of oil demand growth—and the course of the global economy in 2008 is fraught with worries. 

Financial innovation and the globalization of securities helped to lubricate the 

wheels of the global economy during an extraordinary expansion, but it also created 

risks that were not—and still are not—fully understood. The US subprime mortgage 

meltdown is the most current example of misunderstood risk, but is it the last? 

Oil prices can remain high during an economic downturn. In the early 1980s, one 

of the weakest periods of economic growth since the depression of the 1930s, oil 

prices were at very high levels for several years. But eventually, the economy and 

demand catch up: the 1986 oil price collapse was due to a multiyear decline in oil 

demand. 

This year, just as economic worries began to mount, oil prices touched a new high 

of about $110 per barrel. Although oil prices are only one factor affecting the global 

economy, they are a significant one. Because the world economy took $70 per barrel 

in stride does not mean that it would easily absorb $100. If prices hover in the $90- 

$100 plus range for six months or more, then it would be increasingly difficult to 

argue that high oil prices do not have a significant impact on economic growth. 

Moreover, given the growing use of corn-based ethanol, oil prices are now connected 

to food prices, which are rising. And the increase in food prices is a major source 

of inflation in many emerging markets around the world. Oil prices are fluctuating 

in line with the latest economic signals—up and down. This will continue until a 

clearer view of economic growth materializes. But one factor is clear. The price of 

oil will reflect major swings in the value of the dollar—both up and down. 

The CHAIRMAN. Thank you very much. 

Mr. Cota. 

STATEMENT OF SEAN COTA, CO-OWNER AND PRESIDENT, 

COTA & COTA, INC., PRESIDENT, NEW ENGLAND FUEL INSTITUTE, BELLOWS FALLS, VT 

Mr. COTA. Honorable Chairman Bingaman and Ranking Member 

Domenici, distinguished members of the committee, thank you for 

this invitation to testify before you today. As both a petroleum 

marketer and as a representative of two respective trade groups 

that together represent our nation’s independent motor fuel consumption and heating fuel dealers, I appreciate the opportunity 

brought to provide you with insight on extreme volatility and 

record setting prices seen in the recent months on the energy commodity markets. 

I serve as the Petroleum Marketers Association of America’s executive, on their executive committee. PMAA is a national federation of 46 States in regional associations representing 8,000 independent marketers that collectively account for approximately half 

the gasoline and nearly all of the distillate fuel consumed by motor 

vehicles and heating equipment in the United States. 

38 

I’m also President of the New England Fuel Institute, a 60–yearold trade association representing over 1,000 heating fuel dealers 

in related companies in Northeastern United States. The five member companies deliver about 40 percent of the nation’s home heating oil and many market diesel fuel, bio, heat, propane, jet fuel and 

so on. 

Finally I provide insight as co-owner and President of Cota and 

Cota, Inc. of Bellow Falls, Vermont, a third generation, family 

owned business operating as a heating fuel supplier in Southeastern Vermont, Southwestern New Hampshire. My business provides home heating fuel to approximately 9,000 homes and businesses. Unlike larger energy companies most retail heating fuel 

dealers are small family run businesses. 

Also unlike larger companies, heating oil and propane dealers deliver products directly to the doorstep of American homes and businesses. Because of this close association with our customers we 

have deep concerns for their well-being and the general welfare of 

our communities. Few recognize the small business nature of our 

industry. We recently have proposed an array of measures to policymakers in Washington that can assist our industry in assuring 

adequate supply of home heating fuel and insulate the consumer 

from current volatility in excesses that dominate commodities markets. 

First we urge members of this committee and this Congress to 

support our recent and standing request to the Bush Administration to release all 1.97 million barrels of the Northeast home heating oil reserve. Contrary to statements from the Administration the 

release of this product from this reserve may not be tied solely to 

crude—to heating oil differentials for a trigger mechanism. This 

speculation driven vault of futures market with a record price 

surge as seen in recent months perhaps this measure could break 

the back of some of this excess speculation. 

Second we urge Congress and the Administration to implement 

real and substantial reforms to existing law and Federal regulation 

designed to fully insure transparent and accountable and stable energy futures markets. For 2 years now the New England Fuel Institute and the Petroleum Marketers of America and their various allies in the energy market oversight commission have asked for such 

changes and little has been done. Consequences of inaction are now 

apparent and will only continue to worsen. For the sake of all 

Americans and the economy at large, you must act now. 

It has become apparent that excess speculation on energy trading 

facilities is driving this crude runaway train with prices. One example, on January 3, 2008, one floor trader bought 1,000 barrels 

of crude oil and immediately sold it at a loss for about $600. The 

trader deliberately pushed the price of the barrel of crude over 

$100 just because he wanted to tell his grandchildren that he was 

the first person to ever buy crude over $100. 

Commitments in trading like this concerns PMAA and NEFI 

members who argue that recent volatility in crude prices will force 

small business and consumers to pay excessively high energy prices 

that do not reflect supply and demand factors. The rise in crude 

prices in the recent weeks, which has reached $110.21 a barrel on 

March 13, 2008, this is dragged with every single refined petroVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00042 Fmt 6633 Sfmt 6602 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
39 

leum product, which is especially heating oil. Just over 1 month 

also heating oil prices from February 11, 2008, to March 18, 2008, 

have risen from $2.65 a gallon to $3.31 a gallon. 

The price by it comes despite reports by the Energy Information 

Administration, EIA, that heating oil inventories remain around 5 

year averages. Gasoline inventories have also risen dramatically 

reaching a high of $3.33 per gallon on March 17, 2008, at nearly 

two-decade high inventory levels. 

Many heating fuel companies like myself hedge in order to protect the consumers against roller coaster volatility. However, our 

ability to manage in these commodity markets in order to set price 

on economic fundamentals has become less and less reliable. As a 

result so do our hedging programs. As the influence of price setting 

functions on unrelated and under regulated markets in trading on 

over the counter and foreign based exchanges continues to be the 

norm, American consumers are forced to ride the speculative roller 

coaster on energy prices. 

For far too long insufficient oversight and transparency has encouraged excessive speculation. Created a trading environment 

that rewards trading misdeeds like that of the Amaranth hedge 

funds and British petroleum. Loopholes in Federal law that have 

created what I call these dark markets or energy markets engaging 

in futures and futures like contracts, swaps, derivative and trades 

have nearly no oversight and very little Federal oversight and regulation. Today I believe the vast majority of trading occurs on these 

unregulated dark markets. 

More specifically we urge Congress to take swift action to bring 

light to these dark markets by one, closing the notorious Enron 

loophole ripped open by the Commodities Futures Modernization 

Act, which through its trillions of dollars have poured since it was 

created in 2001. Virtually overnight the Enron loophole freed all 

electronic markets from oversight. Congress needs to close this 

loophole and close it for all energy commodities thereby returning 

the CFTC statutory authority that it lost in 2001. 

As an important step in closing this Enron loophole Congress 

must pass the Senate version of the CEA Reauthorization Act included as an amendment on the 2007 Farm bill, HR 2419, which 

is currently in conference. This legislation will reauthorize the 

CFTC and bring greater transparency and accountability to energy 

trading facilities through an array of important policy reforms. It 

is stronger than the CEA Reauthorization language drafted by the 

Presidential Working Group currently under consideration in the 

House Agriculture Committee. Further the Senate legislation also 

gained bipartisan support from the United States Senators Levin, 

Feinstein, Chambliss, Snowe, Cantwell, Coleman, Conrad, Dorgan, 

Lieberman, Collins, Crapo, Durbin and Schumer. 

Two, investigate CFTC’s use of no action letters, which we believe equate to a loophole for foreign markets to gamble with American energy commodities and American economic interests. Under 

no action letters the CFTC may provide regulatory exemptions 

under certain conditions, which are—to which an applicable form 

board of trade, FBOT, offers contracts for delivery within the 

United States. The current process fails to provide sufficient public 

40 

1Official website www.pmaa.org. 

2Official website www.nefi.com. 

notice and consultation and may not take into full account the impact that these letters have on markets. 

Moreover, in order to obtain such exemptions CFTC requires that 

a comparable regulatory authority be present in the country, which 

the exchange operates. Congress should examine whether or not 

Congress determines such regulatory authority be comparable. Finally, we are concerned that no action letters may be or have been 

requested by exchanges to establish electronic platforms with the 

intent to circumvent United States law. 

Three, reduce the dominance of non-fiscal players in the commodity markets. The commodity markets—— 

The CHAIRMAN. Could you sort of summarize the remaining 

points you have to make, please? 

Mr. COTA. The markets have been taken over by the financial 

community. To reference George Soros from his interview yesterday 

on CNBC, we are in the worst financial crisis that this country has 

experienced since 1930. The crisis is exacerbated by the lack of regulation in a variety of investments, not the least of which is energy 

commodities. 

Soros stated further without regulations, markets tend to extremes, not equilibrium. Because of this weakness in the United 

States dollar most of the speculative moneys going into commodities through dark markets to park cash, which will further exacerbate our economic crisis. This is now an economic and national security crisis. Thank you, Mr. Chairman. 

[The prepared statement of Mr. Cota follows:] 

PREPARED STATEMENT OF SEAN COTA, CO-OWNER AND PRESIDENT, COTA & COTA, INC., PRESIDENT, NEW ENGLAND FUEL INSTITUTE, BELLOWS FALLS, VT 

Honorable Chairman Bingaman, Ranking Member Domenici and distinguished 

members of the committee, thank you for the invitation to testify before you today. 

As both a petroleum marketer and as a representative of two respected trade groups 

that together represent our nation’s independent motor vehicle and heating fuel 

dealers, I appreciate the opportunity to provide you with our insight on the extreme 

volatility and record setting prices seen in recent months on the energy commodity 

markets. 

I serve on the Petroleum Marketers Association of America’s (PMAA)1 Executive 

Committee and serve as PMAA’s Brands Director. PMAA is a national federation 

of 46 states and regional associations representing over 8,000 independent fuel marketers that collectively account for approximately half of the gasoline and nearly all 

of the distillate fuel consumed by motor vehicles and heating equipment in the 

United States. 

I am also President of the New England Fuel Institute (NEFI)2, a 60-year-old 

trade association representing well over 1,000 heating fuel dealers and related services companies in the Northeastern United States. NEFI member companies deliver 

over 40 percent of the nation’s home heating oil, and many market biodiesel, 

bioheat, propane, kerosene, jet fuel, off-road diesel and motor vehicle fuels. 

And finally, I provide you insight today as co-owner and President of Cota&Cota, 

Inc. of Bellows Falls, Vermont, a third generation family-owned and operated heating fuel provider in southeastern Vermont and western New Hampshire. My business provides quality home heating fuel to approximately 9,000 homes and businesses. Unlike larger energy companies, most retail fuel dealers are small, familyrun businesses. Also unlike larger energy companies, heating oil and propane dealers deliver product directly to the doorstep of American homes and businesses. 

Because of this close association with our customers, we have a deep concern for 

their well being and the general welfare of our communities. Not only do few recognize the small business nature of our retail industry, but few also grasp also our 

41 

3 42 U.S.C. 6250b(a)(1). 

4 42 U.S.C. 6250b(a)(2). 

5 (BBC News, 2008). 

6 Energy Information Administration, ‘‘U.S. No. 2 Heating Oil Wholesale/Resale Prices,’’ February 11–March 17, 2008. 7The EIA reported that U.S. heating oil inventories were to remain within the 5-year average. 

See Ibid, ‘‘Short Term Energy Outlook,’’ March 11, 2008. 

deep commitment to providing the highest quality products at the most affordable 

and competitive prices. To this end, we have recently proposed an array of measures 

to policy makers in Washington that can assist our industry in ensuring adequate 

supply of home heating fuel and insulate the consumer from the currently volatility 

and excess that dominate the commodities markets. 

First, we urge members of this committee and this Congress to support our recent 

and standing request to the Bush Administration release all 1.97 million barrels of 

the Northeast Home Heating Oil Reserves. Contrary to statements from the administration, release of product from the reserve need not be tied solely to a crude oil 

to heating oil differential trigger mechanism.3 Federal law also permits a release 

from the reserve under discretionary authority provided there is a ‘‘regional supply 

shortage of significant scope and duration.’’4 We are indeed in the midst of such a 

shortage due to: skyrocketing distillate demand overseas; the steepest decline in refinery runs in over two years; infrastructure limitations and pipeline partitioning 

due to the current transition to lower sulfur off-road diesel fuel; and declining interest by small bulk plants and terminals to take on high sulfur distillates such as jet 

fuel and heating oil due to the backwardated market and, as mentioned, the transition to low/ultra-low sulfur diesel. All of these factors will only further exacerbate 

the already speculation-driven, volatile futures market and record price surges seen 

in recent months. 

Second, we urge on Congress and the administration to implement real and substantial reforms to existing law and federal regulation designed to ensure fully 

transparent, accountable and stable energy futures markets. For two years now, the 

New England Fuel Institute, the Petroleum Marketers Association of America, and 

their various allies in the Energy Market Oversight Coalition have asked for such 

changes and little has been done. The consequences of inaction are now apparent 

and will only continue to worsen. For the sake of all Americans and the economy 

at large, you must act. 

It has become apparent that excessive speculation on energy trading facilities is 

the fuel that is driving this runaway train in crude oil prices. For example, on January 3, 2008, one floor trader bought 1,000 barrels; the smallest amount permitted, 

and sold it immediately for $99.40 at a $600 loss. The trader deliberately pushed 

the price of a barrel of crude oil over the $100 just because he wanted to tell his 

grandchildren that he was the first person ever to buy crude oil over $100.5

In addition, in times of a national crisis, excessive speculation can also exacerbate 

an emergency. An example of this comes from a Wall Street Journal article from 

September 2005, wherein an oil trader bragged about his profits following Hurricane 

Katrina. This futures trader bragged that some traders made enough money in one 

week following Katrina that they would not have to work for the rest of the year. 

Comments like these concern PMAA and NEFI members who argue that the recent 

volatility in crude oil prices will force small businesses and consumers to pay excessively high energy prices that do not reflect supply and demand factors. 

And the rise in crude oil prices in recent weeks which reached $110.21 on March 

13, 2008 has dragged with it every single refined petroleum product, especially heating oil. In just over one month, wholesale heating oil prices from February 11, 

2008—March 18, 2008 have risen from $2.65 to $3.31.6 The spike comes despite reports by the Energy Information Administration (EIA) that heating oil inventories 

remain around the five-year average.7 Gasoline prices have also risen dramatically 

reaching as high as $3.33 on March 17, 2008. 

Many heating fuel companies like mine hedge in an effort to protect their customers against roller-coaster-like price volatility on the energy commodity markets. 

Because of our industry’s hedging activities, we strongly support open, transparent 

and well-managed exchanges subject to the rule of law. In fact, it is essential to 

businesses like mine. My company began offering fixed price programs to our customers twenty years ago. We enter into New York Mercantile Exchange (NYMEX) 

based futures contracts with our suppliers, who purchase contracts for future delivery and resell these contracts to me for a profit. In this way, companies like mine 

are able to financially hedge heating fuels for the benefit of the consumer, and help 

protect them against uncertainty and volatility. 

42 

8 Nearly all experts agree that a majority of trading now occurs off of traditional exchanges 

like the NYMEX, and some estimate that number to be 75 percent or more. 9See 7 U.S.C. §2(h)(3), (g) (2006) 

10See 17 CFR 140.99. 

However, the ability of the commodities markets to set a price based on economic 

fundamentals has become less and less reliable, and as a result, so do our hedging 

programs. As the influence of price-setting functions on unregulated or under-regulated markets continues to grow, and as trading on over-the-counter and foreignbased exchanges continues to become the norm, American consumers are forced to 

ride the same speculative roller coaster as the energy trader. For far too long, insufficient oversight and transparency has encouraged excessive speculation and created 

a trading environment that rewards trading misdeeds, like that of Amaranth Hedge 

Funds and British Petroleum. ‘‘Loopholes’’ in federal law have created what I call 

‘‘dark markets,’’ or energy commodity markets engaging in futures or futures like 

contracts, swaps and derivatives trades without adequate federal oversight and regulation. Today, a vast majority of trading occurs on these markets.8

More specifically, we strongly urge Congress to take swift action to bring light to 

the ‘‘dark markets’’ by: 

1. Closing the notorious ‘‘Enron Loophole,’’ ripped open by the Commodity Futures Modernization Act (CFMA)9 and through which billions of dollars have 

poured since it was created in 2001. Virtually overnight, the ‘‘Enron Loophole’’ 

freed all electronic markets from oversight. Congress needs to close the loophole, and close it for all energy commodities, thereby returning to the Commodity Futures Trading Commission (CFTC) the statutory authority that it lost 

in 2001. As an important first step in closing the Enron Loophole, Congress 

must: Pass the Senate version of the CEA Reauthorization Act, included as an 

amendment to the 2007 Farm Bill, H.R. 2419 is currently in conference. This 

legislation will reauthorize the CFTC and bring greater transparency and accountability to energy trading facilities through an array of important policy reforms. It is stronger than the CEA Reauthorization language drafted by the 

Presidential Working Group and currently under consideration in the House Agriculture Committee. Further, the Senate legislation gained bipartisan support 

from U.S. Senators Levin (D-MI), Feinstein (D-CA), Chambliss (R-GA), Snowe 

(R-ME), Cantwell (D-WA), Coleman (R-MN), Conrad (D-ND), Dorgan (D-ND), 

Lieberman (I-CT), Collins (R-ME), Crapo (R-ID), Durbin (D-IL), and Schumer 

(D-NY). 

2. Investigating the CFTC’s use of ‘‘no-action letters’’ which we believe 

equates to a loophole for foreign markets seeing to gamble with American energy commodities and economic interests. Under the no-action letter process, 

the CFTC may provide regulatory exemptions under certain conditions to an applicable foreign board of trade (FBOT) offering contracts for delivery within the 

United States.10 The current process may fail to provide sufficient public notice 

and consultation, and may not take into account the full impact that these letters may have on the market. Moreover, in order to obtain such an exemption, 

the CFTC requires that a ‘‘comparable’’ regulatory authority be present in the 

country where the exchange operates. Congress should examine whether or not 

it determines such regulatory authorities to be ‘‘comparable.’’ And finally, we 

are concerned that no-action letters may be or have been requested and approved for exchanges seeking to establish electronic platforms overseas with the 

intent to circumventing U.S. regulatory authority. 

3. Reduce the dominance of non-physical players in the commodities markets: 

The commodity-related futures markets were primarily created to provide industry participants with a tool to manage inventory and future price related 

risks. However, our industry’s management tool has been dominated by investment banks and hedge funds that profit from price volatility. This market domination is an extremely significant contributor to high gasoline, natural gas, diesel and heating oil prices. Virtually every commodity has experienced price volatility, reaching record levels from gold to wheat and it seems that there is no 

end in sight. 

Hedge funds and investment banks are not driven to provide U.S. citizens 

the most affordable energy supplies; they are driven to profit from volatility. 

PMAA and NEFI believe that margin requirements for speculators who do not 

have the ability to take physical delivery of their product should be dramatically 

increased. Futures market officials could impose a physical delivery component 

for traders to qualify for reduced margins. Earlier this week, Congressman John 

Larson of Connecticut announced legislation that would eliminate the commodVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00046 Fmt 6633 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
43 

ities markets as an investment tool and return the market to the physical players and consumers that have lost faith in its ability to reflect hard fundamentals. 

We realize that there are several different policy recommendations floating 

around Capitol Hill from an array of sources, including legislators, commission and 

administration officials, futures trade groups and the commodity exchanges themselves. We ask that your deliberations take in to account all trading environments 

and all energy commodities, not just the regulation of one commodity at the exclusion of all others. 

I thank you again, Mr. Chairman, and to your colleagues for this opportunity to 

share my insight on this issue. I am open to any questions that you might have. 

The CHAIRMAN. Thank you very much. 

Mr. Eichberger, go right ahead. 

STATEMENT OF JOHN EICHBERGER, VICE PRESIDENT, GOVERNMENT RELATIONS, NATIONAL ASSOCIATION OF CONVENIENCE STORES, ALEXANDRIA, VA 

Mr. EICHBERGER. Thank you very much and good morning. I 

think it’s fitting that I’m the last witness today because my testimony is going to be quite different from what we’ve heard already 

today. I represent the convenience and petroleum retailing industry, which sells about 80 percent of the gasoline in the United 

States. I thank you for the opportunity to share that perspective 

today. 

We’ve been hearing a lot about crude oil today because that’s the 

topic of the hearing. But I think Senator Barrasso commented earlier that that’s not really what your constituents are talking about 

around the water cooler. They’re not talking about the $4 increase 

yesterday in the crude oil price. 

But they probably are talking about the price of retail gasoline 

in their neighborhood. That’s what I’m here to talk about. Hopefully give a little bit of understanding of what happened to the 

market. 

The retail petroleum marketplace is the most transparent, competitive market in the nation. For no other product can your constituents drive down the road, shopping for the best price at 45 

miles per hour. Our members have put their price on big billboards 

on the side of the road to empower consumers to find the best deal 

as easy as possible. Competition is thriving. 

To me, this is a predominantly small business, entrepreneurial 

industry. There are more than 115,000 convenience stores selling 

gasoline. Nearly 60 percent of those are owned by companies that 

operate just one store. Despite common misconceptions integrated 

oil companies and refining companies only own and operate less 

than 5 percent of retail outlets. This number is actually declining. 

Convenience stores rely upon their daily operations to generate 

revenue. This is getting increasingly difficult. In 2006, the average 

convenience store made only about $33,000 in profit. Motor fuel 

sales represented two-thirds of gross revenues, but only contributed 

to less than one-third to the bottom line. 

Retailers make their money by selling in store products like coffee and sandwiches. Gasoline is predominately used to draw customers to the store. This makes it critical that fuel prices are as 

competitive as possible. 

44 

The competition for the consumer is extremely fierce. 73 percent 

of consumers say that price is the most important factor when 

choosing a gasoline retailer. They are so focused on price that 29 

percent of them say that they would drive 10 minutes out of the 

way to save as little as three cents per gallon. If you would run 

the numbers you’d see that they’d actually lose money on this 

transaction. Yet it is exactly this type of behavior that has created 

a situation in which profitability at the pump has reached its lowest level in history. 

According to oil price information service in 2006 the annual average national retail price for gasoline has increased 53 cents from 

2006, has increased 53 cents to about $3.09 so far this year. Meanwhile gross retail margins have dropped nearly half a cent to 13.4 

cents per gallon. This 13 and a half cents must cover operating 

costs, like labor, rent and most importantly credit card fees. You may not realize it at $3.09 every time you swipe your card 

at the dispenser the bank takes 7.7 cents from the retailer leaving 

him with 5.7 cents to cover all of his other expenses. Today the 

banks are making more on gas than the retailers selling the product. This is putting tremendous pressure on the market. 

Crude oil, as we know, is the most significant component of the 

retail price of gasoline. According to EIA in February crude oil was 

responsible for 69.7 percent of the retail price of gasoline. This is 

a sharp departure from historic norms. Between 2000 and 2005, 

crude oil averaged only 45.3 percent of the retail price. The increase in crude oil price has driven the wholesale price of gasoline 

and put retailers in a very precarious economic situation. 

The price for an 8,000 gallon delivery has gone up more than $4,000 in the last 2 years. Yet the average margin for that delivery 

has actually gone down. Many retailers have been forced to extend 

their credit lines while their creditors have tightened lending terms 

to protect the liquidity of their business. This situation is increasing costs incurred by the retailer, forcing them to suspend investments necessary to improve its operations and could ultimately 

jeopardize its ability to obtain future delivery of motor fuel. 

Clearly the impact of crude oil is being felt throughout the economy, nationally and internationally. In January, 45 percent of consumers reported that gasoline prices already affected their spending behavior. Retailers are increasingly concerned of the growing liquidity problems they’re facing as they attempt to pass through 

higher cost of fuel. Even some refiners are struggling to accommodate the higher cost of crude oil. 

Congress has a responsibility to monitor the markets to protect 

against inappropriate behavior and this hearing is one of those opportunities. However, I would like to advise caution as you move 

forward. The motor fuels market is critical to the economic welfare 

of the United States. Any legislative or regulatory actions that 

could disrupt the market, reduce supplies or cause unnecessary 

cost to the system should be avoided whenever possible. 

I urge Congress to work with the affected stakeholders to identify challenges and develop solutions that benefit the long-term interest of the motor fuel market. Thank you for the opportunity. I 

look forward to your questions. 

[The prepared statement of Mr. Eichberger follows:] 

45 

1Data for 2007 is not yet available. 

PREPARED STATEMENT OF JOHN EICHBERGER, VICE PRESIDENT, GOVERNMENT

RELATIONS, NATIONAL ASSOCIATION OF CONVENIENCE STORES, ALEXANDRIA, VA 

Chairman Bingaman, Senator Domenici, Members of the Committee. My name is 

John Eichberger and I am vice president of government relations for the National 

Association ofConvenience Stores (NACS). Thank you for the opportunity to share 

with you today the effects of high crude oil and motor fuel prices on the retail marketplace. 

NACS is an international trade association comprised of more than 2,200 retail 

member companies. The convenience and petroleum retailing industry in 20061 gen- erated $569.4 billion in sales and sold more than 80 percent of the gasoline in the 

United States. 

This hearing focuses primarily on the factors influencing the price of oil. While 

this is a very important topic and one with serious implications for the economy in 

general and investors in particular, it does not necessarily resonate with your typical constituent. However, the downstream effects of crude oil prices, in particular 

the retail price of gasoline, do have a profound impact on these individuals. It is 

this level of trade that I will address today. 

First, let me point out for the Committee that the retail petroleum marketplace 

is the most transparent and competitive market in the nation. For no other product 

can consumerscomparison shop for the best value while driving down the road at 

45 miles per hour. Retailers advertise their motor fuels prices on billboards along 

the side of the road, empoweringconsumers to wield an amazing influence over 

prices in a competitive market. Yet, it is at the same time a market about which 

there is much confusion. 

THE RETAIL MARKETPLACE

Before we can begin to assess the impact of crude oil prices on the retail marketplace, it is essential to have a basic understanding about the composition of that 

market. Withoutspending too much time on the topic, below is a snapshot of who 

controls the retail marketplace: 

The convenience and petroleum retailing industry is dominated by small, independent companies. These companies rely on their daily retail sales to generate sufficient revenues tocover their operations and provide a modest profit, a point reinforced by an April 1, 2008, Associated Press story that appeared in dozens of newspapers and media outlets this week. Just as they do not benefit from the corporate 

revenues generated by the corporations which provide drink and snack items sold 

inside the store, retailers do not benefit from the revenues generated by their petroleum suppliers. In fact, the typical convenience retailer in 2006 reported a pretaxprofit of only $33,360. 

COMPETITION DRIVES PRICE

Although motor fuels are a major source of revenues, representing about threequarters of a store’s overall sales, they contributed only about one-third to gross 

profits in 2006. By contrast, in-store items were about two-thirds of overall gross 

profits but represented only about one-fourthof overall sales. Consequently, it has 

become essential for retailers to price motor fuels at a level that is sufficiently competitive in the market to generate enough customer traffic togenerate sales inside 

the store. Meanwhile, competition for the consumer has become even more intense 

as retail prices have escalated. 


Eich1a.eps
46 

In February 2008, NACS released its 2008 Consumer Fuels Report which reported 

information obtained through interviews with more than 1,200 nationwide consumers conductedbetween December 2007 and January 2008. We sought a better 

understanding of consumers’ behavior with regards to the retail marketplace. What 

we learned helps explain why retailers areunable to generate significant profits at 

the dispenser: 

• 73% of consumers report that price is the most important factor when choosing 

a retailer from whom to purchase gasoline 

• 45% say that high gas prices have had a ‘‘very significant’’ effect on their spending behavior 

• 29% say they will drive 10 minutes out of their way to save 3 cents per gallon 

The bottom line is consumers feel the pressure of higher gasoline prices; they are 

shopping for the best-priced gasoline; and they will go out of their way to save as 

little as a fewcents per gallon. In addition, the competitive market has become even 

more so with the popularity of gasoline pricing websites which enable consumers to 

plan their routes to take advantage of lower prices. Retailers understand these dynamics and are aggressive about pricing motor fuel to maximize their customer volume and their in-store sales potential. 

HIGHER RETAIL COSTS DO NOT MEAN HIGHER RETAIL PROFITS

While retailers set their prices to remain competitive in the marketplace, their 

profitability at the pump is determined by their costs, which have been increasing 

substantially inrecent years. According to the Oil Price Information Service (OPIS) 

weekly report, Retail Fuel Watch, the average national retail price for regular unleaded gasoline has increased 53 cents per gallon from the average of 2006 to the 

most recent week reported. Meanwhile, retail gross margins (the difference between 

retail price and wholesale cost) have declined 0.4 cents. 

It is important to remember when considering profitability in the petroleum industry, one must not take a snapshot approach. At any given time throughout the 

year, a retailer may be losing money per gallon sold or may be making more than 

the averages demonstrated above. However, only by analyzing a complete market 

cycle can one obtain a clear understanding of aretailer’s potential profitability. 

There was a time when retailers would receive notification of price changes once 

a day. The price set in the morning was often sufficient to cover operations for the 

entire day. Morerecently, however, due to the dynamic nature of the market and the 

advent of technology, wholesale prices fluctuate several times throughout the day. 

Given the slim operating margins onwhich retailers operate, they must ensure that 

the gallons they sell will generate sufficient revenues to purchase the replacement 

gallons at the new wholesale price. In a perfect world, if they learn their next load 

will cost an additional 10 cents per gallon, they would increase their retail prices 

10 cents to cover the next shipment. Unfortunately, their competitors may not be 

incurring the same increase in costs and may not enable the retailer to increase 

prices to that extent, at least not immediately. According to the U.S. Energy Information Administration, the statistical arm of the U.S. Department of Energy, it may 

take several weeks before a change in the wholesale price of gasoline may be fully 

reflected in the retail price. (Source: U.S. Energy Information Administration, ‘‘Gasoline Price Pass-through,’’ January 2003). 

Because of the market delay in passing through wholesale price changes, during 

periods of escalating wholesale prices, retailers typically experience a decline in 

gross margins.However, the opposite is true when wholesale prices decline-retailers 

seek to completely pass through costs previously incurred and to recover their lost 

margins by holding retail prices steady for as long as competition may allow. But 

at some point, one retailer in a market will begin to drop prices in search of additional customer volume, and others will follow suit to avoid losing in-store sales. 


Eich2.eps
47 

This is why it is necessary to look at a retailer’s operation from the perspective ofa 

complete market cycle, the duration of which can vary greatly. 

A significant cost not represented in the OPIS report of average gross margins 

is credit card fees. Whenever a consumer uses a credit card to purchase any product 

or service, the banksthat issue the card and that process the transaction collect a 

set of fees. For petroleum retailers, this typically equates to about 2.5 percent. As 

gasoline prices have gone up, so have the fees associated with these transactions. 

Over the time period represented above when gasoline prices increased from $2.56 

to $3.09, credit card fees increased from an average of 6.4 cents to 7.7 cents per 

gallon. While this increase may not seem significant, to the retailer this automatically reduces potential profitability. Subtracting credit card fees from the OPIS reported margins during that time period, retail profitability declined from 7.4 cents 

per gallon to 5.7 cents. Credit card companies and their banks now make more per 

gallon sold than does the retailer. In fact, the convenience and petroleum retailing 

industry paid $6.6 billion in fees in 2006 while generating only $4.8 billion in pretax profit. 

Compounding the impact of credit card fees is the fact that consumers are increasingly turning to this form of payment as prices increase, for a variety of potential 

reasons. The typicalconsumer does not often carry sufficient cash to pay for a $50 

gasoline fill-up, consequently plastic payment has become the default currency for 

many. For others, their household budgetsmay not have sufficient cash flow to cover 

increasing fuel expenses, leaving credit as their best option to finance purchases. 

CRUDE OIL DRIVES WHOLESALE COSTS

The price of crude oil is a significant factor in the retail price of gasoline. Each 

month, the U.S. Energy Information Administration reports the breakdown of retail 

gasoline prices into four sectors: crude oil, taxes, refining, and distribution/marketing. This last category includes all the factors that are incurred after the product 

leaves the refinery, including pipelines, terminals, distribution and retail. The latest 

data available is for February 2008 and indicates that crude oil at the time contributed 69.7% to the retail price of gasoline. This is a sharp departure from historic 

norms. Crude oil’s average contribution from 2000 through 2005 was only 45.3%. 

Meanwhile, the relative contribution of the other components has declined: 

RETAILERS STRUGGLE WITH LIQUIDITY

The overall impact on retailers of higher crude oil prices, and the resulting increase in wholesale and retail gasoline prices, is profound. Not only have consumers 

become more pricesensitive resulting in lower margins, but the overall economics of 

retail operations have become more challenging. As margins have remained static 

on a cents-per-gallon basis over the past few years, inventory costs have not. 


Eich3.eps Eich4.eps
48 

The combination of increased inventory costs with declining profitability has created a potential liquidity crisis for retailers. Retailers now must pay more for the 

inventory they sell, reducing cash flow and increasing liabilities. Compounding this 

increase in costs, many retailers incur additional fuel surcharges for each delivery 

as their distributors seek to cover the increased expense of the fuel required to 

power their trucks. (Similar surcharges also apply to the delivery of in-store items.) 

This has greatly reduced the ability of cash flow from fuel sales to purchase replacement gallons. 

Consequently, many retailers are forced to extend their lines of credit to keep fuel 

in their tanks. This has brought with it additional costs. In addition, terms extended 

to retailers may have historically required payment within 10 days. Now that creditors are seeking to ensure their own liquidity, these terms may have been reduced 

to 7 days or even fewer. Many of these creditors are actually wholesale distributors 

servicing multiple retailers and they are running into their own credit limits in 

their efforts to keep their customers supplied with fuel. As more inventory is purchased on credit, the additional payments of interest have further reduced cash 

flow. 

After months of operating on credit, while wholesale costs have continued to increase and gross margins have remained stagnant or declined, many retailers are 

approaching the limit of their available credit. This forces companies to delay or suspend investments in their operations and, in the most dire circumstances, threatens 

their ability to keep fuel in their tanks. 

CONCLUSION

It is clear that the price of crude oil has a profound impact on the domestic motor 

fuels market, and in particular its retailers and their customers. With higher prices, 

motor fuelsretailers regularly see that increased price volatility reduces already slim 

margins. In the last few years retailers have continued to see both gross and net 

margins decrease to the level where they are at historic lows on a percentage basis 

and the lowest since the the early 1980s on a cents-per-gallonbasis. Quite simply, 

motor fuels retailers cannot survive on fuels sales alone and have to either reinvent 

themselves to expand their in-store offers or sell what is often a multi-generation, 

long-term community-based business. 

While motor fuels retailers are as frustrated by the current state of the industry 

as consumer and policy-makers, I would caution the Senate to proceed carefully 

when consideringpolicy options. The motor fuels market is critical to the economic 

welfare of the United States and any legislative or regulatory actions that could disrupt this market, reduce supplies, or cause unnecessary costs to the system, and ultimately consumer, should be avoided whenever possible. I urge Congress to work 

with motor fuels retailers and other affected groups to come to a solution that addresses the dynamics of the marketplace and affects long-term change. 

Thank you for the opportunity to share the perspective of the nation’s convenience 

and petroleum retailing industry on the impact of crude oil prices on the retail 

motor fuels market. Iwelcome your comments and input at this hearing and in the 

future on how we can help create a system that addresses our nation’s motor fuels 

challenges and can affect permanent change to a system that frustrates both consumers and retailers alike. 

49 


Eich5.eps
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Eich6.eps
51 

The CHAIRMAN. Thank you all very much. I think it’s excellent 

testimony. Let me start questioning. 

Mr. Burkhard, let me ask you about your comment, oil is the 

new gold. That raises some concerns on my part. I think for a long 

time people have seen gold as something to invest in order to essentially hedge against what is happening in other financial markets. It’s a way to hedge against the decline of the value of the dollar. 

I think we’ve seen what’s happened to the price of oil, of gold. 

As more and more people have gone into that market and bought 

gold or bought gold futures, or whatever it is they’re buying. That’s 

something which doesn’t affect the daily lives of most people. 

It doesn’t affect the folks Mr. Eichberger was talking about, primarily in the sense that I don’t need to go buy gold everyday to 

get to work. But in the case of oil, I do have to go buy gasoline refined from that oil to get to work. If we have the same thing happening with oil where it is become a refuge. 

I think you referred to it as people investing in oil seeking a refuge from the decline of the value of the dollar. If that is having the 

effect of driving up the price of oil and thereby impacted what I 

have to pay in order to get gas to come to work, isn’t that something we ought to try to confront and deal with in the financial 

market some way or other, to try to discourage the investment in 

oil strictly as a refuge against volatility elsewhere? 

Mr. BURKHARD. I don’t know if it should be discouraged or encouraged. But what’s happening is the impact of the dollar is simply a reflection of broader macroeconomic trends that are underway. The large forces that have been putting downward pressure 

on the price of oil are really at the roots of oil being viewed as a 

hedge against inflation. 

Oil has a different supply and demand dynamics relative to gold, 

but because of those dynamics it has placed it in a position where 

it can act as a hedge against inflation. 

The CHAIRMAN. My understanding is the value of the dollar is 

declining because of our budget deficit, because of our trade deficit, 


Eich7.eps Eich7a.eps
52 

because of a whole bunch of factors. But I understood your testimony to be that the decline of the value of the dollar is driving up 

the price of oil. 

Mr. BURKHARD. That has been one of the factors that has contributed to it. Yes. 

The CHAIRMAN. Therefore we got more and more people just investing in oil in order to find that refuge against declining value 

in other assets, in this case, the dollar. 

Ms. Emerson, you referred, I think, in your testimony to the fact 

that the physical market does not in any way discourage investment in oil. Should we be doing something? Senator Dorgan in his 

early comments talked about the margin requirements if you want 

to go in and buy oil. 

Is there anything that should be done in a regulatory way or legislative way to discourage oil from being invested in by folks who 

have no earthly need to be buying oil? 

Ms. EMERSON. There’s no quick fix. There’s no easy tool for doing 

that. I would actually agree that the margin requirements should 

be raised. 

The CHAIRMAN. But should they just be raised for oil. I mean, I 

don’t feel a burning desire to raise the margin requirements if 

someone wants to go out and speculate on gold. 

Ms. EMERSON. Yes, I don’t think I can speak to the entire range 

of commodities. But in the case of oil, I do think it seems to be that 

the ratio between how much money you have at stake and how 

much you can make is striking. So I think that would be one step 

to take. 

The CHAIRMAN. So you think having a different margin requirement for oil would make sense, a difference than the margin requirement for something like gold. 

Ms. EMERSON. Again, I only feel I can speak thoughtfully to the 

oil situation. I do think that the margin requirements are a little— 

I do think that’s one tool that the Congress has. But I—or legislation would result in. 

There really aren’t any other easy fixes. I mean, say, drawing 

down the SPR, which I wouldn’t necessarily recommend. 

The CHAIRMAN. Mr. Book, did you have any comment on any of 

this? 

Mr. BOOK. I think that that’s a—I don’t entirely disagree or 

agree. I think that the margin requirement, it’s an experiment that 

deserves a lot of thought. Senator Dorgan mentioned that there 

was 20 days of money chasing each day of oil or something like 

that. I think it may have hit 280 billion, be closer to 30. 

The question is whether or not the market requires 30 days of 

money chases each day of oil in order for it to keep that market 

well supplied. I’m not sure that we know that. There may be an 

optimal size. Margin requirements are the way to start that experiment and that’s reasonable. 

The CHAIRMAN. Senator Domenici. 

Senator DOMENICI. Thank you very much, Senator Bingaman. 

Let me just say to all of you, in particular to you, Mr. Harris, as 

you represent a larger group within your umbrella organization. I 

hope the American people understand what you said and what has 

53 

been said here today about how much is being invested for oil by 

people that are not going to use the product. 

Investors are not buying a tanker full of oil—they’re buying instruments of credit and instruments of purchase and sale and the 

like. If the people understood that, I guarantee you that they would 

insist that we find out, absolutely, whether that’s impacting on the 

price of oil. I don’t believe they would sit for a minute as a group, 

the American people, and let the price of oil rise as high as it is 

if a large percentage of that increase is being driven by speculators 

who are not going to use the product. That’s the people you regulate. Speculators, right? 

They’re good for America. But for me, after today’s testimony, I’m 

seriously wondering how much we have made by way of mistakes 

in not further regulating—at least for the American investment— 

how people could invest in oil that they were not going to use 

themselves. The more I hear, the more I get concerned. 

Please understand all of you at the table, I have heard five or 

six major and minor reasons that represent traditional factors for 

high prices. I believe every single one of them. But I somehow believe that maybe there is something else when it comes to the 

American investor who might be driving this market up because of 

pure speculation. This is a very rich and ripe market. 

I want to also tell you that some of you know I work diligently 

around here. Some of you think I know an awful lot about what 

I’m doing. I knew how to proceed when we put the Energy bill together, but I’m telling you I’m learning this one. So don’t think I 

know as much as I knew about the bill we put together for the 

United States on energy three years ago. This is a very confusing 

subject that seems to confuse everybody. 

I don’t think, Mr. Chairman, that just because this is difficult 

and confusing that we ought to let it go. Some of you testified that 

speculators are not playing that much of a role. Things may be 

going alright at some of your firms, but I’m not sure of that, and 

I’m not sure they’re alright for everyone else. 

Let me just ask, just to have a little bit of dialog with you. Mr. 

Cota, I believe you recommended the legislation that Congressman 

Larson of Connecticut introduced, which would eliminate non- commercial investors in the commodities market. You said that you 

recommended that approach. I don’t assume anything has happened to that bill, has it? 

Mr. COTA. It’s currently just being introduced right now. Nothing 

has happened at this point. 

Senator DOMENICI. Ok. May I ask, Mr. Harris, do you support 

that kind of legislation? 

Mr. HARRIS. I would focus on the fact that speculators are intimately related to hedging in these markets. I think futures markets in particular. You speak to the fact that nobody buys or sells 

oil, but futures markets in particular is set up to discover prices 

and to transfer risk. To the extent that we eliminate an entire 

group of traders from the market, I think that would be detrimental to both of those functions of the market. 

Senator DOMENICI. This would eliminate non-commercial investors in the commodities market, the whole commodities market. 

Your response is that you don’t know what would happen. But 

54 

what do you think may happen? Can you tell me why you oppose 

it? What do you think is going to happen? 

Mr. HARRIS. We’re not in the business of prognosticating, but I 

believe, I guess, my statement was that we if we remove an entire 

group of traders from the market that take on risks that other people don’t want that that diminishes or eliminates the entire need 

for a market. In particular it’s futures markets are there to hedge 

risks and transfer risk from one party to another. I think part of 

my testimony is showing that the longer term futures contracts in 

crude oil in particular, signify that people are worried about future 

prices of oil and speculators and hedgers alike are transacting at 

longer and longer horizons to try and hedge against those price 

changes. 

Senator DOMENICI. See, I don’t know what that means. You’re 

giving me an answer that I don’t understand. Explain that to me 

in ordinary language. 

Mr. HARRIS. Somebody who wants to buy oil for instance, they 

have to contract it. It’s not like stopping at the gas station. You 

can’t just get 4,000, four million gallons of oil delivered today. So 

the futures markets operate in projecting out future needs of purchases of oil. 

One of the risks of future needs is that if you need oil next September, you could wait until next September or next August and 

purchase that oil. The risk that you take in that chance is that oil 

between now and August goes up in price. So in this regard you 

might come to the futures market to lock in the price to buy the 

oil in September. 

So you can transfer the risk from your balance sheet or your 

books right now to some other counter party who’s willing to take 

the risk that oil prices might go up between now and August in our 

markets. If you eliminate the counter party that is willing to take 

that risk it puts me, again, at more risk as a producer, as a manufacturer or as a convenience store operator that I don’t know on 

any one day what I’m going to get for the price. I can’t lock in a 

price in the futures market. 

Senator DOMENICI. Ok. So that overall set of transactions has 

some benefit, in your opinion, in terms of investors and the financing of crude oil from the supplier to the ultimate user. Is that 

right? 

Mr. HARRIS. Yes. 

Senator DOMENICI. Alright. Ms. Emerson, I appreciated your testimony very much. I understand how hard you have worked on trying to answer some of these questions that seem to you to be intractable. 

But you have a chart in your testimony which I think at least 

puts you on record as giving your best estimates. You’ve got one 

chart that shows the factors lifting oil prices. I wish you would 

have had it blown up so everybody could see. But maybe we’ll just 

talk about it. Based on that chart and the rest of your testimony, 

can you tell me how much speculation contributes to an $83 barrel 

of oil? 

Ms. EMERSON. This, as you can see, because this chart is only 

$90 or $85. It was made well before the recent run up in prices. 

55 

Senator DOMENICI. Yes. I guessed $83, but how much would 

speculation contribute to $85 oil? 

Ms. EMERSON. You know I’m reluctant to put a specific dollar 

sign on that because I think what—— 

Senator DOMENICI. What percent is it? 

Ms. EMERSON. I don’t think you can even put a percent. I don’t 

think that moves the dialog forward, trying to identify a specific 

dollar amount for speculation. I think it’s, you know, it’s—can we 

say today’s price is $85 fundamental and $20 speculation. I think 

that kind of layer cake analysis it’s not really useful to us because—— 

Senator DOMENICI. Ok, now let me tell you, ma’am, and excuse 

me. I’m not interested in a view of the layer cake impact. I’m interested in how we can understand the problem. Now if you don’t 

have that box in there at all in your analysis then I would say let’s 

button up the hearing. It’s one thing if an expert says there is 

nothing, no speculation involved. But you say there is some. 

Ms. EMERSON. Ok. 

Senator DOMENICI. You understand? 

Ms. EMERSON. Yes. 

Senator DOMENICI. I’d just like to know what percent you think 

it is because it’s rather significant if you look at your chart A. I’m 

not able to put on exact percent on the ‘‘speculation’’ box—is it 

about ten percent? 

Ms. EMERSON. Let me define speculation and then I’ll give you 

that number. 

Senator DOMENICI. Ok. 

Ms. EMERSON. Speculation, and I think I want to make a distinction between investment and the casino example used earlier. Speculation, and I think part of the reason of the hearing is in part the 

purchasing of oil by institutional investors. I think Mr. Book here 

mentioned the California pension fund purchasing oil. 

To me this is buying an asset to hold like you would buy an equity to hold. They’re buying that for their members of their pension 

plan to hold value. That’s one kind of speculation. Then on top of 

that, of course, there is some day-to-day trading that is perhaps a 

little bit more short term. Not necessarily where you’re buying the 

oil to hold it as an investment in your portfolio. 

If I were to add the two of those together to get back to your 

question, you know, and I had to give you, and this is a gut call. 

If I had to say, I’d say the fundamental price is probably somewhere in the 1980s or 1990 or 1995 at the most. Probably there is 

some additional strength in the price as a result of not just sort 

of the gamblers in the casino, but in terms of actual institutional 

investors who see this as a way to hold value when they can’t hold 

value necessarily in the equity markets or they want to diversify 

their portfolio. 

Senator DOMENICI. I understand your statement. Your explanation to us now makes sense to me. I just think eventually in my 

own analysis I have to go back beyond this and see if I could organize in my thoughts what would be the case if we did not permit 

oil to be speculated upon in any way, even the decent way that you 

mentioned. 

56 

If we, from the beginning, had said that isn’t going to be around, 

I believe there still would have been plenty of capital for oil. I believe people would have invested in it. But they would have been 

closer to the ultimate user than to the faraway investor. 

I can’t do that yet, but I can have somebody look at it for me. 

I thank you very much. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. 

Senator Dorgan. 

Senator DORGAN. Mr. Chairman, thank you. Let me make a couple of comments and then ask a couple of questions. 

I want to hold up the quote from Mr. Gage who has testified before this committee. This is November 6. I think the price of oil 

was around $85 then. 

But here’s what he said. He’s one of the top analysts with 

Oppenheimer. He said there’s no shortage of oil. I’m convinced that 

oil prices shouldn’t be a dime above $55 a barrel. Oil speculators 

including the largest financial institutions in the world, I call it the 

world’s largest gambling hall that’s open 24/7. Totally unregulated, 

like a highway with no cops and no speed limit. 

You know, I don’t know. Thank you. I don’t know what all the 

facts are. I don’t disagree with what’s been said. I think the value 

of the dollar has an impact. 

I mean you’d have to be drunk not to understand when you run $800 billion yearly trade deficits you’re not going to have some effect on the value of the dollar. I mean, you know, everybody understands that’s coming at some point. So, I understand all of this has 

an impact. 

I also think there’s a fairly substantial amount of evidence that 

there’s too much speculation. We had EIA, Mr. Caruso say it was 

about 10 percent of the price. I don’t know what it is. He thinks, 

Mr. Gage thinks it’s about $30 a barrel. Mr. Harris, you don’t think 

it’s very much. 

Now Mr. Harris, I want to tell you. I mean I’ve read about the 

speculative bubbles. This is not quite that. I mean I know that they 

used to sell tulip bulbs during tulip mania for $25,000 a tulip bulb. 

Sounds a little nuts four centuries later, doesn’t it? But it happens. 

You have speculative binges. 

I think there’s some speculation going on here. We do have as 

was referenced by a question a moment ago, we have people involved and interests involved now. They are buying oil they will 

never get from interest that have never had it all to provide liquidity. 

I’m all for liquidity. Every market needs liquidity. I think we’re 

way beyond liquidity here. I understand that, you know, we put on 

blue suits and then we come and describe what’s happening. But 

we really don’t know what’s happening except drivers know. Truckers know. Airlines that close their doors know. 

We need to think about, as best we can, what kind of a normal 

market mechanism should exist and how would it work? I’m involved with Carl Levin to try to close the Enron loophole with some 

of my colleagues. It’s an unbelievable loophole. 

Mr. Harris, my understanding is that your staffing at the CFTC 

at a time when we need referees is somewhere near a 33-year low 

and that third of a century, you’re at the low point. At a third of 

57 

a century when we’ve got these run up and these dramatic markets 

and you’re supposed to be the referee. My understanding also is 

that you come and testify to us based on what you know not on 

what you can’t know because a substantial amount of that, I call 

it dark money, a substantial amount of that dark money is elsewhere. You can’t see it and you don’t know it. 

It’s why, for example, a 32-year-old trader with a hedge fund 

named Amaranth, as you know, held huge sway over the price this 

country paid for natural gas not so long ago. It controlled, I think, 

70 percent of the natural gas commodities of this country. You all, 

the CFTC, finally said, that you can’t do that, you’ve got to stop. 

Finally you said that. They he just went to the intercontinental exchanges. Then you couldn’t see him. He continued to do it anyway. 

So, you tell us what you know today. I appreciate your being 

here. But you can’t tell us what you don’t know. There’s a lot that’s 

dark for you. 

So, and Mr. Book, you either have bad judgment or bad vision 

suggesting your performing in front of Elvis here. I mean does anybody here look like Elvis to you? 

[Laughter.] 

Senator DORGAN. But I appreciated the comment of coming to 

the Congress, but this is not an Elvis committee. Let me ask—— 

The CHAIRMAN. I think all of us take exception to that comment. 

[Laughter.] 

Senator DORGAN. When you said it I immediately leaned over to 

the chairman. I said, it’s unbelievable he would refer to the chairman and the vice chairman as Elvis, but at any rate, we’re pleased 

that you’re here. 

Mr. BOOK. I think highly of Elvis, sir. 

[Laughter.] 

Mr. BOOK. You. 

[Laughter.] 

Senator DORGAN. Let me ask about this issue of margin requirements. It is so interesting to me that if you want to go in the stock 

market and buy a margin you pay about a 50 percent margin, I 

think. If you want to go control some oil or natural gas at the moment, you pay 5 to 7 percent. So you can control a substantial 

amount of the commodity with a very small investment. 

Does anybody here think that that ought to be changed? Mr. 

Cota? 

Mr. COTA. Yes, Senator. The amount of leverage that you get in 

these markets is just tremendous. You’re doing ten times the 

amount of leverage trading by having a low margin requirement in 

commodities. It should be the same as all other equities because we 

become an investment tool. It’s no longer about the base commodity. 

To answer Senator Domenici’s question from earlier about how 

much we’re paying to excess speculation. I think it’s a minimum of 

a dollar a gallon. You know that’s very significant. 

As to your point, Senator Dorgan, which is completely accurate, 

nobody can prove that because there’s no data. The Amaranth’s 

study was done by the Senate Investigations Committee was as 

close as we got. They had a figure of about 20 percent minimum. 

58 

That was back when crude oil was trading about $50 a barrel. So 

we’re way beyond that. 

Senator DORGAN. It took them well over a year to do that study. 

It took them subpoena power. It was something that couldn’t have 

come from our regulators, which I think, describes this deep hole 

that exists where dark money moves around. Without transparency. I think the market is not working properly. Now I don’t want oil to go back to $10 because I think what happens is you dry up all investment for development here at home. 

But neither do I want it to go to $110 because investment banks 

and hedge funds, who never want, in most cases, don’t want to take 

possession of oil ever, just want to effectively gamble in the marketplace. So the victim here is the consumer and the country. 

I mean it’s not insignificant that two airlines have closed their 

doors in the last couple days. It’s not significant that was on the 

news last night, the truckers said, you know, we can’t continue 

doing this. So I want the price to be reasonable. 

I do think, however, this hearing that the chairman has called, 

and I appreciate it, is about the issue of speculation. Is there something happening in the marketplace that we don’t quite understand 

that you can trace to speculation? The EIA says yes, but it’s only 

about 10 percent. Others say it’s much more. But it has a profound 

impact and will continue to have a profound impact on this country. 

There are certainly other things we have to do. We’re going to borrow $800 billion in fiscal policy this year. I know they say that 

the Federal budget deficit is going to be 400. It’s not. We’re going to borrow $800 billion in fiscal policy. We’re going to borrow $800 billion in trade policy. That’s $1.6 trillion against this 

economy in 1 year. That’s unsustainable. 

So I know there are all kinds of other issues. But the price of 

oil has a profound impact on virtually everything else as well. I 

think there’s a substantial portion of that that has no relationship 

to supply and demand. 

Mr. Harris, do you agree with my analysis that at a critical time 

when we need a referee, you can’t see a lot of what you should be 

able to see and your staffing is at a 33-year low? 

Mr. HARRIS. I think it’s a fairly well known fact that we’re at historically low staffing. It’s a fairly well known fact that we’re at historically high volumes in every commodity asset to monitor. So I 

would be supportive of, I guess, the reauthorization of our, that’s 

pending now in front of Congress. That would be a positive development from our standpoint. 

Senator DORGAN. The issue that you can’t see a lot of what you 

need to see in order to really understand all of the markets? 

Mr. HARRIS. I think one of the things I wanted to bring forth on 

my testimony today is that we—in these markets we actually do 

know quite a bit. The natural gas case with Amaranth in particular, went to highest futures. We also have pending legislation 

in front of Congress on that to try to close some of those loopholes. 

In the crude oil markets though we do have an information sharing agreement with the FSA for instance where’s there’s a large 

amount of trading in crude oil in the Brent contract and in ICE Futures UK. We get daily reports from the ICE Futures UK on tradVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00062 Fmt 6633 Sfmt 6602 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
59 

ing activity in their markets in addition to the West Texas intermediate on NYMEX. So one of the—and part of our data and the 

large trader data as well is that we can identify large groups of 

traders classified by speculators or managed money in the case 

that I presented today where we can look at what groups of traders 

are doing. So we do have some tools to dig fairly deeply into these 

markets where you probably don’t have the same capacity, for instance in the stock market, to understand who’s buying and selling 

on a daily basis. 

Senator DORGAN. Mr. Chairman, I’ve exceeded my time. But let 

me just say what’s going on these days with the Fed and our country’s decision makers is that there’s not a lot of risk for being a big 

speculator because if you’re big enough in this country, we’ll just 

take care of your losses at some point along the way which should 

raise another discussion, another committee perhaps. 

The CHAIRMAN. Thank you. 

Senator Barrasso. 

Senator BARRASSO. Thank you very much, Mr. Chairman. Following up with Mr. Harris. Alan Greenspan actually 4 years ago, 

argued that in a tight market where supplies are not easily expanded that the futures investing does impact price. That was a 

time when oil was at $40 a barrel. 

Now watching all your charts, I got the impression that you 

weren’t necessarily agreeing with the former chairman of the Fed 

on that. Would you like to expand because I see Ms. Emerson moving her head yes, up and down? 

Mr. HARRIS. The impression is futures markets do serve a price 

discovery function. So in the sense that, as I mentioned earlier, 

people forward contracting looking to purchase oil in the future will 

use the futures markets to do that. I can’t speak to whether I agree 

or disagree. 

We’ve heard that there’s a large speculative premium for a number of years now. One of the issues there is we heard that it was 

$50 a barrel. Then it’s $60 and now we’re at $100. 

I find it hard to believe that the speculative premium could be 

that variable over that short a period of time. We do see prices still 

reacting to fundamental changes in political risk around the world. 

It seems to make a little bit more sense to me. 

Senator BARRASSO. Do you draw a distinction between the markets where you have good oversight? When I think of excessive 

speculators, there’s hedge funds, general asset managers, pension 

funds or sovereign wealth funds. To me a difference is that sovereign wealth funds do have actually a control over the supply from 

some nations. Some nations have a wealth funds that have that. 

Is that something you feel you have enough information to comment on and if that impact is different than a hedge fund or a general asset manager? 

Mr. HARRIS. We do have fairly rich information, I would say. 

We’re aware of the sovereign wealth fund issue. I’m not aware that 

we identified how sovereign wealth funds trades in our data. 

Senator BARRASSO. Mr. Book, then, if I could ask you. You wrote 

the Associated Press article of March earlier this year where they 

talked about sovereign wealth funds adding speculative heat to the 

already red hot market. I think your comment was: while Persian 

60 

Gulf sovereign funds would be taking a risk since oil prices could 

decline, it isn’t the worst investment idea you could have, Book 

added, if you control the oil supply. Would you like to comment on 

that? 

Mr. BOOK. I would love to. I think that if you believe in markets 

you believe in transparency. If you believe in transparency, you believe in shame. Price discovery and actors in markets who exploit 

markets routinely should be excluded from markets. 

I do believe that fund managers, as a profession, are not the 

same thing as oil producers as a profession, nor sovereigns as a 

profession. In fact, the sovereign wealth funds will have an incumbent on them, not just for oil, but for all commodities and all investments to make clear the distinctions in who controls the money 

and who controls the decisions. I think with clarity there is no 

problem. 

I also, as I suggested in the article, I think that there are reasons why you might not want to do that. You might, if you paid 

this guy to diversify you out of the oil revenues that make your 

country go and then he puts you back in oil, that may not be the 

best performing fund manager you could hire. So it’s not clearly the 

best decision. It may simply reflect, as I said in my testimony, that 

there aren’t a lot of other good investments available right now for 

professional investment managers of any stripe, whether they be 

sovereign, hedge, mutual or other. 

Senator BARRASSO. Our abilities, in the United States, to regulate sovereign wealth funds in terms of what they’re able to do in 

international markets would be quite limited would you say? 

Mr. BOOK. Yes. The way they can invest can be through regulated vehicles. Again I think that the appreciation and their assets 

under management has occasioned already among the OECD and 

the IMF vigilance. I think it’s appropriate. I also think it’s important to not judge before we know. 

Senator BARRASSO. Ms. Emerson, in your written testimony you 

concluded it with consuming governments will be compelled to take 

action to protect their economies. What specific government policies 

would you propose or endorse right now in terms of what we as a 

consuming nation should be, will be, compelled to take to protect 

our economy? 

Ms. EMERSON. The way I see this problem is it’s a structural one. 

There’s no quick fix. I think that the kinds of policies that I see 

as being critical are going to be polices to conserve, to promote fuel 

efficiency. 

I mean, if you look at it from the U.S. prospective, it’s all about 

transportation fuels. It’s not about anything else. And we’ve made 

some steps last year with raising the CAFE ́ standards and of 

course the EPA is considering CO2 emissions regulations, which 

would indirectly improve fuel economy as well. 

We just need to be as vigilant and as aggressive on conservation 

and fuel efficiency as we can be because I don’t see us rebuilding 

a whole lot of spare capacity. We’re not going to return to $30 oil, 

certainly not in my lifetime. 

Senator BARRASSO. You had made the issue of transportation 

fuels. That, Mr. Cota, if I could visit with you for a second. I think 

61 

people are able to be good windshield shoppers at 45 miles an hour 

like Mr. Eichberger talked about driving around. 

I drive around the State of Wyoming. All of us drive around our 

States, long distances between one community and other. You can’t 

shop on that one main street when you’re 75 or 100 miles away. 

You may see a jump in prices, as I did this last week, driving 

around Wyoming. Maybe 25 cents per gallon and all the prices in 

one community may be 25 percent higher or lower than another 

community even though they’re all pretty close in price. But that 

differential of $3 to $3.25 per gallon is a 7-percent difference. 

Would you like to comment on that and why that differential can 

be so great? 

Mr. COTA. I think that deferential could exist in the current market simply because of the volatility that’s occurred. There has been 

a 70-cent change in the wholesale price within a 30-day period. So 

just depending on just a matter of days what could occur within 

that market could justify that. 

There have been a number of days where just the high and the 

low in some of these contracts has had us spread as high as 20 

cents a gallon within the day. That’s just one day. So, you know, 

I get price changes as often as three times a day. Often I don’t 

know what I actually paid until I’ve actually gotten the invoice the 

next day and it’s draft out of my account. So that would explain 

that. It goes to underscore the volatility that we have in the markets. 

To bring up your point on the sovereign funds, which I think is 

really critical. That’s a national security issue. If you have a sovereign fund that doesn’t particularly like the United States and you 

want to go in a dark market through a derivative type of bilateral 

deal. You’re selling the commodity that you want to also hurt the 

other guy with, you could make a huge impact for very short 

money both to jeopardize that economy and maximize your own 

commodity. 

We would have no way of knowing. There is no oversight. You 

don’t even have the data. 

Senator BARRASSO. Mr. Eichberger, anything else you’d like to 

add? 

Mr. EICHBERGER. I think Mr. Cota kind of nailed it on the head 

is that the volatility in the wholesale market is tremendous. I was 

with a retailer earlier this week who told me over a ree day period 

he had something like a 20 cent increase in his wholesale cost in 

one day, a twelve cent drop the next day and an eight cent increase 

the following day. The volatility is incredible. Retailers are constantly chasing that cost where their competition will allow them 

to do. 

In different markets, competitive pressures are very different. 

The cost basis of their operations are very different. The distribution challenges of getting product to those retail locations could be 

very different. So the variables that influence retail price are huge. 

Senator BARRASSO. Thank you, Mr. Chairman. I think I’ve exceeded my time. 

The CHAIRMAN. Senator Lincoln. 

62 

Senator LINCOLN. Thank you, Mr. Chairman. As usual thanks for 

bringing us together on an important issue, but a very complicated 

one as well. 

Just a couple of questions. Mr. Harris, you said repeatedly I 

think that future markets existed to discover prices and limit risk. 

You just I think answered Senator Barrasso’s question with a 

version of that. 

I guess, although I do agree to some degree that that exists in 

a properly functioning futures market. I guess, would you also 

agree the flip side of that, that an improperly functioning futures 

market could distort prices and certainly inadequately limit risk resulting in the kind of excessive speculation that perhaps could 

exist? 

Mr. HARRIS. I totally agree. In fact that’s the mandate of our organization is to monitor and investigate any activity that might be 

deemed suspicious, manipulative or otherwise in the market. So we 

do have—— 

Senator LINCOLN. Do you feel like you’re agency or your department’s got the adequate means to be able to do that? 

Mr. HARRIS. I don’t work for the enforcement division in particular. I think it’s pretty well known again that we’re at low staffing levels. We’re at record volumes in these markets. 

We’re doing the best that we can. We have record numbers of enforcement cases as I understand. We have hundreds of investigations going on any given day in these markets to try and make 

sure that there is no nefarious behavior going on in any market. 

Senator LINCOLN. Ms. Emerson, following up on Dr. Barrasso’s 

question about what countries can do. You also, and I’m apologizing because I had to excuse myself and these questions may 

have been asked, but you did touch on the impact of biofuels and 

other new fuels and the effect that they could have on the price of 

oil is certainly of particular interest to me. Many of us come from 

agricultural-based States and innovative States. 

My State has a diversity of feedstocks that could be used. We’ve 

got a lot of interest among our Ag community. But also in terms 

of the innovation and technology that people are looking for in renewable fuels. 

I’d like to hear, I guess, more about what you believe and how 

you believe that maybe, perhaps, that could affect oil markets and 

what needs to be done to grow those industries properly in a way 

that could make a positive impact. 

Ms. EMERSON. I think biofuels, both in the United States market 

and also in the global market are, must be seen as a portfolio approach. They’re not a magic bullet. 

Senator LINCOLN. Right. 

Ms. EMERSON. But they certainly can be part of the solution. Obviously they have to be developed in a way that deals with the food 

or fuel issue and with the inflation issue. So you have to look very 

closely at the kinds of import, excuse me, input materials and the 

way in which they’re grown. 

Then now we have the issue of are they grown in such a way or 

are the biofuels manufactured in such a way that they use more 

energy and/or emit more CO2. So I tend to be a little bit of a 

biofuels skeptic only because I find there’s more emotion and exVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00066 Fmt 6633 Sfmt 6602 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
63 

citement than careful planning with biofuels. Maybe that’s what 

you have to do. Maybe you have to start with the excitement and 

then sort of throttle back and come up with the appropriate plan. 

Senator LINCOLN. Second to Hollywood, we’re all about glamour 

here in Washington. 

[Laughter.] 

Senator LINCOLN. So you may be correct that creating the enthusiasm and excitement for things is what gets us started and then, 

obviously, practicality. I have a research physician in my house and 

certainly looking for the practicality. But I know in our State everything from algae to chicken litter, poultry litter to, you know, 

switch grass and a whole host of other things, looking at those as 

alternative for fuel and energy are great ideas in a sense that 

they’re feed stocks that make sense and don’t necessarily distract 

from other places in the marketplace. So your point is well taken 

in terms of making sure that we create that balance in terms of 

where those feed stocks come from. 

Mr. Eichberger, your testimony you mention that the affects of 

the increased use of credit cards to purchase fuel at convenience 

stores and the fees that are a part of that transaction. I have just 

met with my Arkansas marketers, petroleum marketers. I heard an 

awful lot about that issue. 

They, our petroleum marketers, are seeing, as you say, not only 

the volatility and the fluctuation in terms of price at the pumps. 

What they have to deal with, but also the lack of transparency. As 

well as what, you know, when that volatility happens what happens to them in terms of their cost of doing business. 

Could you expand any on your testimony as to how extensive you 

believe that problem is and what your association would see as a 

solution to that? 

Mr. EICHBERGER. It is the number one issue facing the retail market today. In 2006 overall convenience stores paid $6.6 billion 

in credit card fees. They only generated $4.8 billion in profit. 

This is an escalating situation. The card will assess a fee of 

about two and a half percent on average on every gallon sold. As 

the price of gasoline goes up, their revenues go up. Yet they have 

absolutely have no risk in terms of buying product, putting in the 

ground, making sure you don’t release in the environment, making 

sure that everybody is filling up properly and you’re doing all your 

business operations. They just skim it right off the top. 

So as retailers who are constantly chasing the volatile wholesale 

markets and trying to figure out how they’re going to be able to 

break even on gasoline to see seven and a half cents from every 

gallon come right out of their pocket, it’s a major issue. A lot of retailers are in the situation where it is make or break. If something 

is not done to level the playing field and give them some relief at 

the pump, they may not be able to make a profit on gasoline in the 

long term. It could really destroy their economic well being. 

Senator LINCOLN. I appreciate that. You certainly confirmed 

what I’ve been hearing at home. So thank you. Thank you, Mr. 

Chairman. 

The CHAIRMAN. Senator Murkowski. 

Senator MURKOWSKI. Thank you, Mr. Chairman. Thank you ladies and gentlemen for your testimony this morning. 

64 

Mr. Eichberger, listening to you this morning, we recognize 

that—we’re always looking for some scapegoat, somebody to blame. 

The guy that you’re getting the gas from at the pump seems to be 

the quickest and easiest but it reminds me of, you know, the scene 

in the airport where you’ve got the customer who is chewing out 

the ticket rep there for the cancellation of their flight. To a certain 

extent the retailers are in that situation. So I think your testimony 

here this morning was important for people to hear and to understand. 

Ms. Emerson, I think you said at least a half dozen times here 

this morning there is no single answer. There is no silver bullet. 

This is complicated. This is complex. 

But it seems that we are very, very quick to try to attach blame. 

But if we were to just take some of the profits from the oil companies, all would be fine in the world. I think it is important to understand how many different factors really go into what affects the 

price of oil. Why we’re seeing what we’re seeing today. 

As I listened to all of you, well, it’s not clear to me that any one 

of you is wiling to attach a percentage or a price on what the speculation is in terms of all those factors that go into the price of oil. 

We recognize that speculation does play a role, maybe some of you 

think it’s a much more limited role than others. But the other factors, the supply and demand, the geo-political factors, the oncoming 

role of China and India, it’s clear to me that we’re looking at this 

and recognizing all that comes into it. 

Mr. Burkhard, in your testimony you mentioned these new fundamentals and the first was the aspect of the cost structure and 

the reality that the labor and the materials that go into it are just 

continuing to increase. Then the second of those fundamentals was 

the global financial dynamics. You speak again of the role of China 

and India. 

I look at those two fundamentals that you’ve identified and I just 

see them continuing. Does this mean in your opinion that the price 

of oil will continue to rise because we’re not able to contain these 

two areas or do we plateau it at some point here? 

Mr. BURKHARD. The—first of all can’t continue to rise forever. On 

the cost side, over a long period of time there will be more people 

and equipment entering the industry. But one important thing to 

keep in mind is in for most of the 1980s and 1990s for a generation, there is a whole generation of people that skipped entering 

the petroleum industry because of low prices and industry consolidation. So it’s going to take time to reinvigorate the ranks of particularly on the technical side of the oil industry. But 10, 15 years, 

we hope to see more relief on that front. 

On the China, India issue, their aspirations for higher living 

standards are like anywhere else in the world. But there are limits 

in terms of price that those countries can take. They are, on average, the per capita income is lower than it is here in the United 

States. 

So when we get to—if we were to have a sustained oil price of 

let’s say 110 to 120. By sustained, I mean 6 months or more, not 

a day or two. We would expect to see demand, even in those countries start to be negatively affected and push that could over time 

begin to take some of the pressure off price. 

65 

Senator MURKOWSKI. I don’t think any of you have specifically 

mentioned the growing role, the domination really, of the nationally owned oil companies and what role this may play in driving 

up the prices worldwide. Could someone speak to that? Ms. Emerson? 

Ms. EMERSON. It is absolutely the case where we’re seeing a shift 

in the balance of power among oil companies from the integrated 

majors that we all know to national oil companies around the 

world. That’s in part because they, in their host—in their home 

countries they hold a lot of reserves. Actually they’ve become much 

larger companies and often times they’re backed by their government in some of their investments. 

I think some commentators have said that this is just all together a bad development. I think that’s a too simplistic. I think 

some of the national companies that I personally deal with are 

making very big steps to invest in oil production and in oil refining. 

They will probably significantly impact some of these capacity restraints that we have. 

So I think we have to adjust our thinking a little bit to understand that, you know, they’re big players too now. It’s not just 

about the Exxons and BP and Shell. 

Senator MURKOWSKI. So you’re viewing it as a positive in the 

sense that it will add to capacity. 

Ms. EMERSON. Yes. What we’re seeing is significant investment 

in capacity and from many national oil companies or companies 

that are technically private, but behave a little bit like national oil 

companies. 

Senator MURKOWSKI. But what about their aspect then as a nationally owned oil company to really attempt to control, to what extent they can, the available prices. Are you not as concerned about 

that aspect of it? 

Ms. EMERSON. I think it’s a complicated issue. You have to look 

at national oil companies in terms of whether they are part of a 

net importing country or part of a net exporting country. So the decisions that a CNPC to a Chinese company would make would be 

different than a Saudi Aramco would make. 

I think in the case of the national oil companies in net exporting 

countries they’re making so much money. They are definitely 

pumping that, to some degree back into capacity. Not necessarily 

maybe as much as we would like, but certainly they’re building 

that capacity. That’s a good thing. 

But it does mean that it’s going to be those companies controlling 

the flow more so than in the olden days when Exxon and Mobil 

were sort of controlling the flow for the global market. You know, 

it depends a little bit on how you perceive the objectives of their 

governments. 

Senator MURKOWSKI. Mr. Cota. 

Mr. COTA. The national oil companies, the exporting national oil 

countries and their companies have more subtle yet very large impact. It’s in how they are taking the United States dollars, which 

they will continue to take into diversifying their portfolio. Then 

they in that way, part of that diversification to get out of United 

States dollars is to do the arbitrage deals to buy Euros, other foreign currencies and in the last form of cash which is commodities. 

66 

So in their efforts in these predetermined arbitrage programs of 

diversifying their portfolios they are driving up the same thing that 

they’re trying to diversify out of. So they’re making a large impact 

by increasing the price, inadvertently, I don’t think directly and inadvertently because they’re trying to get out of United States dollars. As the United States dollar goes down everyone’s buying commodities worldwide in United States dollars, not just energy. As 

you diversify out of the United States dollar because that’s declining, you’re going to go into commodities, which is going to drive the 

price up and which is going to return more to them. 

Senator MURKOWSKI. My time is up, but Mr. Book had a comment. Let me ask him. 

Mr. BOOK. Senator, I just—I did speak to that briefly in my written remarks. I just wanted to point out that if you’re going to satisfy global petroleum demand, you’re going to need an and within 

demand, not an or. So the good thing about the national oil companies is that as they become richer and gain access to greater technology, they add to global supply on the market, typically when 

they make the investments that have been discussed. 

The other part of and was mentioned earlier, it’s bio- fuels, it’s 

alternatives, unconventional sources of petroleum. It is also access 

where you can have it. We are—I go to Norway sometimes to see 

clients. They have national sovereign wealth and oil producing, I 

think they might be importing, but I don’t know. 

They say they take the—they like to tease me because we don’t 

produce all of our offshore oil. Yet they’re one of the greenest, sort 

of, national economies in terms of their ethos and their culture. 

They have paired responsible production with conservation. If 

you’re going to get to and, I think responsible production and conservation are both parts of the story. 

Senator MURKOWSKI. Alaska wants to help there. Thank you, Mr. 

Chairman. 

The CHAIRMAN. Thank you. 

Senator Cantwell. 

Senator CANTWELL. Thank you, Mr. Chairman. Panelists, thank 

you for being here. There was an earlier testimony this week in the 

House by oil company executives and an executive from Exxon 

Mobil was quoted as saying, ‘‘based on supply and demand fundamentals that they have observed that they estimate the price of 

oil should be about $50 to $55 per barrel.’’ That’s what the oil company executives believe. 

I think this hearing is very important. So I’m asking starting 

with you, Mr. Burkhard and Mr. Book. Did you predict that oil 

prices a year ago would be at $100 a barrel without a major oil 

supply shock or disruption? Did either of you predict that? 

Mr. BOOK. I’m wrong currently. I have this year’s price at $85. 

Senator CANTWELL. Mr. Burkhard. 

Mr. BURKHARD. We were lower than the current price too because of the impact of the dollar and the rising cost as well. 

Senator CANTWELL. If I asked you to predict what oil prices are 

going to be in 6 months, do you think you could give me a good 

basis for that? 

Mr. BURKHARD. I could describe to you in detail the assumptions 

that would go into the outlook, but whether that actually happens 

67 

or not is a different story. But it’s if the dollar does weaken more 

than it’s difficult to see oil prices declining. 

Senator CANTWELL. Mr. Book, do you want to comment on that? 

Mr. BOOK. I believe in fact that $85 reflects a couple of things 

that do make sense to me. I’ll enumerate them even if I’m wrong 

about the magnitude. The marginal nonevect barrel is probably 

$70. 

Senator CANTWELL. Ok. Actually you’ve already made my point, 

which is just this that we didn’t, no one predicted this without a 

major oil shock. Here’s where we are today. 

When you are asked to predict again, which is trying to have 

some predictability in the markets with some certainty so people 

can hedge with some expectation, so that they can protect themselves. Yet we’re basically saying this is all over the map. We don’t 

have the fundamentals here. We don’t have the fundamentals that 

are giving everybody the certainty and predictability we would like 

to see. 

It wasn’t that long ago. I became a Senator in 2001 and at that time OPEC was doing all they could to keep oil prices between $22 

and $28 a barrel. So my point is this thing is way out of control 

and it’s causing great impact to the economy. I just don’t understand why we aren’t being way more aggressive. 

I plan next week when the FTC is before the Congress committee 

to ask them to hurry up and expedite the rules that were given to 

them in the new Energy bill on anti-manipulation provisions to 

make sure that petroleum markets, just like electricity markets, 

have the proper oversight. But Mr. Harris, my question is for you, 

just yes or no. Do you believe in closing the Enron loophole? Yes 

or no? 

Mr. HARRIS. Yes, absolutely. 

Senator CANTWELL. So the CFTC will support that. Under your 

current authority while you may be able to look at the ICE markets, you don’t have any ability to do any enforcement of wrongdoing. Is that correct? 

Mr. HARRIS. That’s right. 

Senator CANTWELL. So, a big problem exists today in the fact 

that we have online trading that doesn’t have the enforcement and 

oversight. So we—to me, I don’t care how many people we have. 

I mean, we ought to be able to, Mr. Chairman, get the oversight. 

That reminds me, you know, it took the Snohomish County PUD $100,000 to prove that Enron manipulated markets. It didn’t take 

a lot. It didn’t take the FERC to do that. Although they later found 

that, it took a little industry to bait a little entity to hammer home 

the point. 

My second point is in this chart, Ms. Emerson. If you could— 

your chart on factors lifting oil prices you have just in time. My 

question is how much does the industry moving from a 30-day actual physical supply of oil to a just in time trading on paper of supply impacted the market in not having—in basically making a lot 

tighter supply and thereby more speculation. 

Ms. EMERSON. I think, absolutely, the movement to just in time 

inventories has exacerbated the tendency of the supply chain to respond or prices to respond very quickly to supply chain hiccups. 

You know back in the 1980s and early 1990s we had as much as 

68 

30 days and we’re probably around 22 days now of supply that the 

physical market is holding. To the degree that you reduce your capacity, you reduce your inventories. That, yes, absolutely, you cede 

control to others in terms of short-term price dynamics because you 

can’t discipline the speculator by dumping some oil into the market. 

You know in the olden days we used to talk about Brent squeezes. You know, someone would buy a bunch of Brent cargoes, but 

Shell or BP would just add another cargo and that would discipline 

that behavior out of the markets. So yes, you’re right without the 

spare capacity and without the additional inventory it does make 

short-term speculation or short term trading have a bigger impact. 

May I also respond to your other question just to be sure? 

Senator CANTWELL. It’s up to the chairman. I’m out of time but 

it’s up to the chairman. But I will just say these things are a lot 

clearer. 

Mr. Cota, thank you for your testimony. I think you were very 

crisp. I think when the oil industry is coming to us saying that 

they, in fact, see problems in this. It’s time for us to clearly list out 

the things that need to happen and closing the Enron loophole. Basically looking at how to make sure that there’s more physical supply for less speculation, making sure that the FTC gets about their 

job. 

It’s just clear there is not—we can’t go from 2001 at 28 to where 

we are today at over 100 and then having people play these guessing games and thinking that we’re going to have any kind of functioning markets. There’s just too much going on here. If we were 

going to protect our economy we have to be a lot sharper at closing 

what are the lack of functioning market trends that are absent 

here. I think they’re pretty clear. So, go ahead Ms. Emerson. 

The CHAIRMAN. Ms. Emerson, go ahead. Give whatever response 

you want and then Senator Sessions has some questions. 

Ms. EMERSON. I’ll just do 2 seconds and that’s just to say about 

this issue of is the fundamental price at $50 or $80 or $90. One 

of the things that I wanted to make clear in my testimony this 

morning is that 2007 we had a very strong fundamental development which did move prices well above $50 for supply/demand reasons. So I don’t want to leave the impression that the potential 

speculative premium is something between $50 and $100. It’s probably closer to $80 and $100. 

The CHAIRMAN. Alright. Senator. 

Senator CANTWELL. For a lot of families even that is a big difference. Thank you. 

The CHAIRMAN. Senator Sessions. 

Senator SESSIONS. Ms. Emerson, it seems a little odd to me that 

you and Mr. Book seem to think that the national governments 

that are taking ownership of the oil in their country in contradiction to normal free market principles is not a problem. Mexico has 

tremendous reserves, yet their production is down. That’s generally 

accepted because of corruption, inefficiency that is typical in these 

country’s governments and in their production capacity. 

Isn’t that a factor in the decline? Venezuela, showing a decline 

in their production, has large reserves. Isn’t that a factor? 

69 

Ms. EMERSON. I absolutely agree that these countries are pursuing policies of resource nationalism. Their policies may or may 

not be beneficial to consuming governments. 

Senator SESSIONS. But I’m talking about their own country. In 

the short run or at least, it seems to me, they’re not very effective 

in producing oil and putting it on the market. Because they’re inefficient and less efficient and productive than private oil companies 

that have to compete on the marketplace. 

Second, isn’t the biggest winner in all of this countries who own 

their oil reserves? When the prices go up dramatically, aren’t Saudi 

Arabia, Hugo Chavez, and people like that just counting the 

money? Nothing has changed in their country. They have the same 

amount of production and they’re getting more than two times 

what they were getting just a few years ago for their oil reserves. 

Ms. EMERSON. Absolutely. But I would make a distinction that 

there are different kinds of producers. I wouldn’t necessarily put 

Venezuela and Mexico which are having terrible problems for both 

political and institutional reasons with some of the Persian Gulf 

producers who are absolutely investing. 

Senator SESSIONS. Is production increasing in some of the Persian Gulf countries? 

Ms. EMERSON. Their production capacity is increasing. 

Senator SESSIONS. They’re taking advantage of these high prices. 

Ms. EMERSON. Absolutely. 

Senator SESSIONS. A little more effective than some other countries. What is the average? I’ve heard various figures. I’d like to 

know what is generally considered to be a fair estimate of the profit that oil companies make today on a gallon of gas. How many 

cents per gallon? 

Mr. Eichberger, you’re in the business of—— 

Mr. EICHBERGER. Yes, Senator. Probably the best proxy you’d 

have is the Energy Information Administration breakdown on the 

retail price of gasoline. They do it each month. They break it down 

to what crude oil contributes, taxes, refining and then everything 

below refiner. 

If you look at the average for 2007 refinery operations and profit 

was 17 percent. 

Senator SESSIONS. 17 percent. 

Mr. EICHBERGER. 17 percent. 

Senator SESSIONS. So a $3 gallon is 30, 45 percent—45 cents per 

gallon. 

Mr. EICHBERGER. A $3 gallon would be 51. It would be 51 cents 

on a $3 gallon. But you have to keep in mind that’s also their operation cost as well, not just profit. 

Senator SESSIONS. Right. I was at a town meeting and a local, 

one of your guys, I guess, pointed out to me at $100 a barrel at 

42 gallons a barrel. He wrote it on a napkin and gave it to me. 

That’s $2.52 right there plus all the other costs that go into it. 

But I’m told it only costs in Saudi Arabia about $8 a barrel to 

produce a barrel of oil to get it out of the ground. 

Mr. COTA. Probably less. 

Senator SESSIONS. So I mean this is a huge amount of money 

that’s going now perhaps over 80 percent of the oil of the world 

today is owned by governments. Is that correct? So when the OPEC 

70 

meets and they talk about production levels. They control their production. They are taxing the American consumer. That’s what 

they’re doing because this is not a free market price. It’s a cartel. 

OPEC is, in itself, a price fixing mechanism. They work to fix the 

price. I think one sense of what we ought to do is focus on an internet foreign policy that deals honestly with that question. 

I would like to ask, whoever would like to comment on it, a question about diesel fuel. It’s very troubling to me the price of diesel 

fuel is considerably higher, Mr. Eichberger, at your stations than 

gasoline. It should be less. 

Diesel automobiles get 35 to 40 percent better gas mileage, Ms. 

Emerson, which would be one of the ways to conserve. Fifty percent 

of Europe’s automobiles are diesel. Why are we having such a high 

price for diesel fuel? Mr. Cota, I see you raise your hand. 

Mr. COTA. Part of it has to do with our new flavor of diesel, ultra 

low sulfur diesel. So we now produce the highest quality diesel on 

the planet. We were a net importer of diesel prior to having this 

new standard. 

Now with the arbitrage of the dollar and the Europeans having 

a higher demand. They import diesel and export gasoline. So because the Euro is so strong, our diesel in the United States is going 

to Europe. Much like our bio—— 

Senator SESSIONS. I asked the Energy Department that a few 

weeks ago and they told me we’re not exporting diesel to Europe. 

Mr. COTA. You can take a look, I, well, I’m not a trader. I don’t 

work for the government. My understanding is that the arbitrage 

deals are encouraging cargoes in New York Harbor to go to Europe. 

Senator SESSIONS. Mr. Burkhard. 

Mr. BURKHARD. I think a fundamental reason for that, for the increase in diesel prices, is that is where demand globally has been 

strongest, China and Europe in particular. The demand for diesel, 

globally, for several years has been much stronger than gasoline. 

Senator SESSIONS. My time is up. But I guess my question is why 

aren’t we seeing any move to refinery? In the pure cost factor, even 

with the higher grade of diesel fuel that you referred to, it still 

should be produce-able at less cost than a gallon of gasoline, should 

it not? 

Mr. COTA. It’s all what the crack spread is and the refiners say. 

That’s a question for the API group. They can tailor outputs. We 

are the last economy to focus on gasoline. The rest of the world, 

as was stated, is moving toward the diesel because it’s cleaner and 

higher efficiency. 

Senator SESSIONS. Mr. Chairman, I just hear that a lot from my 

trucking community. 

The CHAIRMAN. Go ahead if you have any additional questions. 

Senator SESSIONS. I would like to follow up a little bit on that. 

It seems to me that there’s a slow transition. Would any of you 

comment on that? A slow transition to a diesel economy. When I 

ask about it, the Energy Department official said it was a lack of 

refinery capacity. Mr. Book and Ms. Emerson. 

Mr. BOOK. Senator, there’s a transition from the light duty vehicle perspective is about 230 million cars and SUVs that have to 

cycle out of the fleet and diesel vehicles to cycle in. So from the fuel 

side of the story there is the part of the story have been discussed. 

71 

The other part is how do you get higher efficiency vehicles into the 

fleet and get rid of the ones that were there before? 

Scrap yard rates for cars are now at about 5 percent, 5.5 percent, 

which means you have a 15 to 20 year waiting period. In the 70s 

the height of that energy crisis, you were in the 12 to 13 percent 

scrap rate. So to the extent that you can get into a different car, 

you need to not to just have the new car made, the fuel to put in 

it, but you’ve got to get the old one off the road. 

Senator SESSIONS. But it’s still selling for substantially more 

than gasoline, which indicates to me that there’s a large profit 

being made. 

Ms. Emerson. 

Ms. EMERSON. Senator, you raise a really critical question. I 

think this is the big issue that needs to be addressed. The United 

States refining industry is configured with catalytic cracking and 

coking to take medium sour crude oil and turn it into gasoline. 

We’re not configured to maximize diesel production. We’re configured to maximize gasoline production. 

Right now refiners in the United States are working very hard 

with their gasoline configurations to make additional diesel because diesel demand is growing. It’s growing. It’s the only fuel right 

now that’s growing in terms of—and it’s growing fast. Part of the 

reason it’s growing is because we’re importing Chinese products in 

San Francisco and driving them to New England. 

So it is the trucking demand is what is—so we have a structural 

problem there in that we have a refinery kit that really wants to 

make the gasoline. So the refiners are doing what they can to bend 

and tweak that to make more. They absolutely want to make more. 

And at the same time we have a very strong demand for. 

Mr. EICHBERGER. Senator, if I could also add. I think you heard 

about the fleet turnover. I think we need also to look at Federal 

policy to a degree. The auto industry is not really being encouraged 

to produce a whole lot of the new diesel engines. They’re being encouraged for just flexible fuel vehicles, hybrid vehicles, higher efficiency gasoline vehicles. The cars coming in imports are predominately going toward hybrid and the domestic auto manufacturers 

are going to flexible fuel vehicles. 

So there is a preference through Federal policy to go to biofuels, 

to go to higher efficiency gasoline, the electric hybrid cars rather 

than going to the cleaner, more powerful, more efficient diesel engines that we’ve been talking about the last 5 minutes. Until we 

figure out and get away from this prejudice against new generation, fossil fuel powered vehicles, diesel is not really going to take 

off in a consumer’s mind when you look at vehicles they can purchase from auto manufacturers. I think we need to balance our priorities, looking long-term. 

We have a bio-fuel, renewable fuel standard we need to implement. But if we also want to increase fuel economy we need to look 

at all options and make sure they’re all on the table and not prejudiced against one verses the other. I think that’s a challenge that 

we have going forward from a policy perspective. 

Senator SESSIONS. My only bafflement is why, with this kind of 

margin for diesel, we aren’t seeing more refining coming forward 

to meet the demand that already exists? 

72 

Mr. COTA. Senator Sessions, with the profitability and refineries 

are measured in crack spreads. There’s a gas crack and there’s the 

distillate crack. Typically in the summer, in the spring and in the 

fall, refineries will switch their production to maximize whatever 

they think the seasonal demand is going to be. I think for the first 

time refineries are looking seriously hard, as was alluded to earlier, 

about maximizing more diesel. 

Truckers are pretty smart when they know about efficiency. Diesels run a lot more efficient. Otherwise we’d be running gasolinepowered tractor-trailers, but we’re not. As this trend goes, if the 

profitability, I mean, the crack spread with distillates is going to 

remain very high, the refiners will switch the refining over time, 

but it takes a huge amount of time and a huge amount of capital 

investment in order to do that. The crackers like $400 million for 

a refinery or a coker. 

The CHAIRMAN. Thank you very much. I think it’s been useful 

testimony. We will try to sort through it and figure if there are any 

initiatives we can pursue in this committee. Thank you very much. 

[Whereupon, at 11:47 a.m. the hearing was adjourned.] 

[The following statement was received for the record.] 

STATEMENT OF VICTOR J. CINO, PRESIDENT, PYRAMID OIL MARKETING

I. The Clinton and Bush Administration have allowed mergers of oil companies in the last ten years which have decreased dramatically competition in the 

United States. 

Crude oil price began to rise dramatically after four critical mergers of 

major oil producers, two during the Clinton Administration, and two more during the Bush presidency. In 1998, BP merged with Amoco. In 1999, Exxon 

merged with Mobil. In 2001, Chevron acquired Texaco, and in 2002, Conoco Inc. 

merged with Phillips Petroleum. All these mergers reduced the number of competitive oil producers in the marketplace. Less competition led to an easier path 

to higher crude oil prices. 

II. The major oil companies utilized tragic events to foster fear that oil supplies would be disrupted and allowed them to increase prices at will, regardless 

of ample world supply. 

The major oil companies benefited enormously from devastating and tragic 

events which hit the United States, and which made it easier for them to increase crude oil prices: 9/11; the Iraq War, and Katrina. The average price of 

oil in 2001 was $17 per barrel, but after 9/11, the average price of crude oil in 

2002 went to $24 per barrel. Larger hikes in crude oil occurred in 2003 and 

2004 after the Bush Administration went to war against Iraq. Crude prices shot 

up to $27 per barrel in 2003 and $36 in 2004, doubling the price of a barrel 

of oil in just three years. 

The Iraq War kept prices climbing into the summer of 2005. The price of oil continued its rise above $40 per barrel. Then in the fall of that year, Hurricane Katrina devastated New Orleans, disrupted for a few days, Colonial Pipeline supply heading to the Northeast, shut down, for about two weeks, 20% of 

refinery production in the Gulf of Mexico, and cut off supply temporarily to the 

West Coast. Crude oil and gasoline prices soared even though the Northeast 

and the West coast possessed enough above ground stocks of crude and gasoline 

supply to last 45 days. 

The media mistakenly suggested then that there would be major long term 

supply disruptions resulting from Katrina, and so the average price of crude oil 

in 2005 shot up even higher to $50 per barrel. But even though oil and gasoline 

supply began to flow normally within three weeks, crude oil remained at $50, 

and oil prices never retreated after Katrina. 

Fed by doom and gloom news over oil supply by an overzealous national 

media aching for shock news, and an oil industry which continued to feed misinformation to the American public. Oil commodity traders began to hike up the 

value of crude futures, and thus the average price of oil artificially rose again 

in 2006 to $56 per barrel, doubling the price of oil from its average price in 

2003. 

73 

Oil traders have played an important role in driving up the price of oil 

since they have recognized that the major oil companies no longer have any restrictions on its ability to raise prices here in the United States and elsewhere. 

III. Major oil companies have a national influence on the media, the Executive branch of the U.S. government as well as the Congress. 

Historically, major oil companies have effectively influenced the national 

media by releasing information conducive to generating fear that oil supply disruptions could occur. This year is no different. A few months ago it was Kurdish 

rebel attacks coming out of Iraq and into Turkey that would disrupt oil supply. 

This past week oil strikes in Scotland and Nigeria allowed Traders to hike up 

oil prices by purchasing oil futures on that news, and oil companies predictably 

followed suit and did just that, jumping to an incredible $120 per barrel. On 

Tuesday, April 29, a New York Times article claimed that oil supply was not 

keeping up with rapidly rising global demand and ‘‘the outlook for oil signaled 

an unprecedented scarcity of oil.’’ 

That statement can be no further from the truth as evidenced by the historical twenty five year ability of the oil industry to meet demand world wide 

crude oil, gasoline and distillates. 

The argument that major third world countries are increasing demand so 

rapidly that oil supply cannot keep up with demand is absolutely false and is 

not based on the historical data. There is more than ample supply worldwide 

to meet oil demand. The argument is being used by oil propagandists to help 

drive up the price of oil worldwide. 

The growing economies of China and India would push global energy demand for crude oil in the year 2030 beyond the limits of oil producers to supply. 

The New York Times reported just a few months ago, but the truth is that oil 

demand from these two major economies is barely making a ripple in the ability 

of the oil industry and OPEC to supply world needs. 

The price of crude oil also keeps rising because of the political and financial 

influence of the major oil companies on the Congress and the Bush Administration. Large amounts of political contributions have created enormous oil industry influence in Washington for politicians to stand on the side of big oil and 

do nothing about rising crude oil prices. The president is from an oil state and 

his family has strong ties with the Saudis. His administration, consequently, 

will do nothing to discourage higher crude oil prices. 

IV. There is a general apathy on the part of governments and consumers 

when faced with rising oil prices because the major oil companies have too 

much strength and financial clout to fight, and now with recent mergers and 

huge profits, they are more formidable. 

Oil and gasoline consumers have demonstrated a distinct indifference to the 

rising prices of crude oil. It is an apathy based on consumers’ essential resignation to the idea that we can do nothing about rising oil prices because of the 

overwhelming power and financial strength of major oil company producers and 

oil producing nations. 

Given these reasons why crude oil prices are so high, where should the 

price be? I think the price of a barrel of crude oil today should be close to $50, 

the price a barrel of crude oil just after Hurricane Katrina hit New Orleans. 

This price takes into consideration all three major events which adversely affected crude oil prices, and were the events most responsible for a doubling of 

price from year 2000 when a barrel of crude was $23. 

V. Why the price of crude oil is close to $120 per barrel. Oil price increases 

have been artificially induced to rise by major oil producers, OPEC, oil lobbyists 

and media friends of big oil. Historical data suggests that crude oil supply has 

met demand easily. 

In the past ten years, worldwide oil demand increased by 12.7 million barrels per day, from 73.3 million barrels per day (mbd) in 1997 to 86 mbd in 2007, 

but oil producers easily met that additional demand, producing as much crude 

oil as demand required. 

In fact, except for a few short term disruptions to the supply of crude oil, 

producers have met crude oil demand worldwide for the past thirty years, and 

have shown during this period how sophisticated and efficiently balanced the 

system of oil supply and demand has worked, almost to perfection 

That stated, there is no viable reason for the current price of crude oil to 

be hovering at $120 per barrel. Therefore, one must conclude that the current 

price of crude oil has been artificially induced by the fear of short supply as a 

result of the three major events that shook the world, and which have provided 

the major impetus and opportunity for world oil producers to continue to raise 

prices of crude oil unchecked since 2005. 

74 

With an existing balance of supply and demand prevalent, there is no other 

reasonable explanation as to why oil rose almost 400% from its level of $23 per 

barrel in year1999 to almost $120, except that the control of oil by the major 

oil producing countries and big oil, have trumped the law of supply and demand. What can we expect in the near future? 

VI. New discoveries of crude oil are clearly demonstrating the world’s ability 

to meet crude oil demand and the record of discovery proves that. It is nonsense 

for anyone to think that we are running out of oil or in short supply, even for 

the short term. 

I think the discovery of new oil reserves and increased production of oil in 

African countries, Canada and elsewhere, as well as the development of new 

technology for extracting oil from the ground, combined with an expected global 

economic slowdown, will create the conditions for lower oil prices over the next 

five years. 

Angola, with eight billion barrels of proven reserves, is already producing 

1.4 million barrels per day, and while Sudan produced a nominal 380,000 barrels per day, that figure is expected to climb dramatically. Chad produced approximately 157,000 barrels per day. More oil producers in the marketplace 

translates to more competition and lower prices. 

Also, the world is finding more oil. Proven crude oil reserves are increasing 

yearly. Canada is now extracting oil from sand and shale. The U.S. Energy Information Administration asserts that Canada’s proven oil reserves exceed 176 

billion barrels. Its market for this secure source of oil is the U.S. More oil availability means lower prices. 

By contrast, Iraq boasts 115 billion barrels of crude reserves, Iran has 136 

billion barrels, and Saudi Arabia, weighs in at 262 billion barrels. There is no 

doubt that the Saudis can increase oil production at the turn of a spigot, and 

since the U.S. is prepared to defend Saudi Arabia in an overheated Middle East, 

it can aid the U.S. by cranking out more oil. 

VII. Current levels of proven crude oil reserves worldwide are more than 

ample to meet crude oil demand for thirty to fifty years. 

Total proven crude reserves worldwide stand at an incredible 1.31 trillion 

barrels. Can anyone seriously believe then that these countries will not be able 

to meet any kind of increased oil demand for the next fifty years, given the extraordinary amount of oil reserves they have available? The question still remains, however, at what price? 

VII. The major oil companies have shifted their refinery production from gasoline to distillates because the refiner gross profit on diesel and other distillate 

products have risen dramatically to 61 cents per gallon , while the refiner gross 

profit on gasoline is now just 20 cents per gallon. 

United States fuel oil needs are primarily based on the use of consumer and 

industry demand for gasoline, while economies overseas in Europe, China and 

India rely more heavily on crude oil. Since the major oil companies are making 

more money on distillates, they have shifted refinery production to distillates 

and shipping this product overseas where they can make 61 cents per gallon 

on diesel, for example. 

Consequently, there has been less buildup of gasoline inventory from this 

shift in refinery production in the United States which would have driven down 

the price of gasoline as a result of current declining demand resulting from a 

slowing of the economy. 

VII. What can our government do to halt the rising of oil prices in the marketplace when traditional laws of supply and demand are being trumped by the 

tragic and serious manipulation how then can we as consumers become a factor 

in reducing oil prices? What can we really do to thwart this seemingly 

unstoppable rise in oil prices? 

A. The government must immediately step in. as President Nixon did in 

the early 70s and impose price controls on the entire oil industry, particularly where it affects United States consumers: at the refinery gross profit 

level and at the gasoline pump. 

B. Immediately demand the oil companies to begin using their huge profits and vast resources to begin constructing four and perhaps five refineries 

in strategic locations throughout the United States. Refineries will assist in 

production dramatically, lessen the impact of shocks to the flow of oil and 

gasoline into the economy, and make us more independent. 

C. Consider the breakup of recent oil mergers mentioned earlier which 

have caused a complete lack of oil competition and helped contribute to rising oil prices and a downtown turn in the United States economy. For the 

75 

long term we can encourage Washington to provide funding for the research 

and development of hydrogen fuel cells which can replace fossil fuel as a 

source of energy. 

D. We can take seriously the role of renewable energy in meeting our energy needs by demonstrating a serious attitude to increasing the use of soft 

energy: solar, biomass, that is, wood, landfill gas and ethanol, for example, 

hydroelectric energy and wind energy. We can express that attitude in a 

major effort to change our energy sources. Soft energy accounts for 7% of 

our total energy sources. We need to double that amount in the next five 

years and oil prices will drop accordingly. 

E. We can think conservation by purchasing hybrid automobiles. We can 

take public transportation in big cities. We can turn off the lights at home 

and at the office. We can turn down the thermostats at home, We can ride 

bikes and walk instead of drive. Above all, we need to think about cutting 

back on our energy usage. If all these efforts come into play, the price of 

oil will be declining and not rising. 

F. The United States Senate needs to take a serious look at commodity 

traders activities to determine if there has been any manipulation of oil 

commodities which have driven up the price of crude oil. 

(77) 

APPENDIX 

RESPONSES TO ADDITIONAL QUESTIONS

RESPONSES OF JEFFREY HARRIS TO QUESTIONS FROM SENATOR BINGAMAN

Question 1. Do you disagree that increased market participation of institutional 

investors and increased volatility of oil prices are correlated? 

Answer. The Commodity Futures Trading Commission (CFTC) Office of the Chief 

Economist (OCE) agrees that market volatility can be affected by different traders 

in the futures markets. We monitor and measure volatility in a number of ways. 

These include volatility measures using daily and intraday prices from futures markets as well as implied volatility measures computed from prices in markets for options on futures. Generally speaking, we find that volatility in the NYMEX WTI 

Crude Oil contract has been relatively stable over the past five years, by each of 

these measures. While oil prices have been rising, the variability of price changes 

(volatility) on a daily or intradaily basis has not been rising concurrently. 

To examine the question of the role and impact of speculative activity in price 

changes from a year ago, OCE has closely tracked changes in speculative positions 

to determine if those changes have played a role in pushing prices upwards. We 

have done this multiple times for various time periods. We have not found a consistent relationship between the positions that speculators take and subsequent 

price moves, but we continue to closely monitor and test the data. 

Question 2. I am hoping you can further explain the CFTC’s position on the role 

of institutional investors on oil prices. We had Guy Caruso testify before this committee last month that more than 10% of today’s oil prices are likely the result of 

speculation. On Tuesday, we heard the major oil companies testify before the House 

Committee on Energy Independence and Global Warming that speculation is an important factor in today’s high prices. The other five witnesses on this panel make 

compelling cases that institutional investors are playing a key role in determining 

the oil price. Your organization seems to be the lone voice arguing that increased 

market participants investing in commodities does not affect the price of those commodities. 

Answer. At the CFTC, we are very aware of the increase in the price of crude 

oil and its impact on Americans. We have also heard the statement by some that 

speculators are the cause of this increase and our analysis has looked very closely 

to try to find evidence of that. It is true that all futures market participants impact 

the overall prices of a commodity—that is the very essence of the markets. We are 

rigorously analyzing the markets daily to discover what is driving these high prices. 

Using some of the most comprehensive data available to market regulators anywhere in the world, OCE has closely examined the buying and selling behavior of 

every group of market participants in crude oil futures markets. Based on our analysis of this data, to date, CFTC staff economic analysis indicates that broad-based 

speculative or manipulative forces are not driving the recent higher futures prices 

in commodities across-the-board. 

Because our comprehensive data set allows the OCE to know what groups of traders are buying and selling each day and we know how prices change each day, many 

of our tests examine the relations among position changes by various trading 

groups, including managed money traders (this category includes hedge funds) and 

swap dealers (who bring the growing investments of commodity index funds to our 

markets). OCE has analyzed the behavior of these different trading groups in the 

crude oil markets over numerous time periods to see whether their buy and sell activities induce daily price changes in the market. The only consistent outcome from 

these analyses has been that speculative traders appear to react to price changes— 

that is, speculative traders will be net buyers in the market on the day following 

price increases and net sellers in the market on the day following price declines. 

We consistently find that crude oil price changes are related only to trading arising from groups within our commercial categories (which include producers, manuVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00081 Fmt 6601 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
78 

facturers, and others). On days when groups of commercial traders are net buyers 

in the market, subsequent prices increase and when these traders are net sellers, 

prices subsequently fall. We consider this evidence that markets are functioning 

properly. Comparing the various participant categories, commercial traders are the 

most likely to consistently have information about the fundamental value of oil. 

Question 3. Does the CFTC believe that other commodities are similarly unaffected by increased investment? For instance, does the CFTC maintain that the 

price of gold and agricultural commodities is affected only by supply and demand 

for the physical products? 

Answer. Generally speaking, the answer is yes. Based on our analysis, OCE believes that futures markets are generally reflecting supply and demand conditions 

for the physical products. The fundamental supply and demand conditions in many 

agricultural markets are very tight, and in many of these markets we have seen 

very high prices. Ethanol has increased demand for corn. The USDA projects that 

approximately 30 percent of the current year’s corn crop will be used to produce ethanol. This demand increase has, by all accounts, resulted in higher corn prices. In 

addition, this demand increase is having ripple effects. Land diverted to corn 

tightens the available supply for other crops, raising the prices for those crops as 

well as inducing higher dairy and livestock prices because of the increased costs of 

feed. Poor growing conditions around the world, most especially two successive years 

of drought in Australia, have reduced wheat supplies. World demand for agricultural commodities continues to be very strong, even in the face of high prices. In 

addition, other fundamentals such as a weak dollar and increased demand from 

around the world has impacted the markets. 

Question 4. According to EIA, the fundamental supply-demand balance cannot ex- plain more than $90 of the current price of a barrel of oil. How would CFTC explain 

the difference between that price and today’s $100+ market prices? Does CFTC feel 

that it has a more thorough understanding of oil market fundamentals than EIA? 

Answer. We are very aware of the increase in the price of crude oil and its impact 

on Americans. We have also heard the statement by some that speculators are the 

cause of this increase and our analysis has looked very closely to try to find evidence 

of that. To date, OCE has not seen any analyses or data that point to a particular 

target price for oil. As you know, the CFTC is not a price-setting agency nor do we 

predict prices for commodities, rather the CFTC’s mission is to oversee and regulate 

the trading of commodity futures and options in the U.S.—in which price discovery 

occurs—and accordingly, our expertise is in this area. 

OCE believes the data we collect on a daily basis is adequate for supervising the 

futures markets and oil trading done on those markets. We have comprehensive and 

detailed data on various groups of speculators and, based on the buying and selling 

of these traders, our analysis shows little evidence that changes in speculative positions are systematically driving up crude oil prices. 

Question 5. Please describe to us the means by which the CFTC goes about educating itself on oil market issues. How many staff positions are dedicated to oil market issues? Does CFTC regularly engage either EIA or private oil market analysts 

as it seeks to better understand oil markets? 

Answer. The CFTC is organized into Divisions with specific areas of expertise, including the Office of the Chief Economist, the Division of Market Oversight, the Division of Clearing and Intermediary Oversight, the Office of the General Counsel, 

and the Division of Enforcement. 

The Commission program that is most directly involved in oil market issues is the 

Division of Market Oversight (DMO) surveillance program. Four economists are assigned to the oil complex as part of their surveillance responsibilities. (In addition, 

supervisors and support staff also work on assignments that involve the oil complex.) These market surveillance professionals closely and continuously monitor 

trading activity in the petroleum futures markets in order to detect and prevent instances of possible price manipulation. Surveillance staff members receive daily reports identifying all large long and short positions in NYMEX petroleum futures 

and options-on-futures markets. Using these reports, Commission economists monitor trading in the petroleum markets, looking for large positions and trading activity that reveal attempts to manipulate petroleum prices. In addition, our analysts 

monitor prices and price relationships, looking for price distortions evidencing manipulation. They also maintain close awareness of supply and demand factors and 

other developments in the petroleum markets through review of trade publications, 

and through industry and exchange contacts. CFTC surveillance staff routinely reports to the Commission on surveillance activities at weekly market surveillance 

meetings, including information about market fundamentals and monitoring of trading activity throughout the markets. In addition, surveillance staff, who continually 

monitor the markets for potential problems, will immediately alert the Commission 

79 

and senior staff whenever there are significant, time-sensitive developments in the 

markets. Staff of the Energy Information Administration (EIA) has attended these 

surveillance meetings on several occasions. DMO also consults with relevant government agencies (such as EIA in the case of energy products), commercial participants 

(such as oil producers, consumers and marketers), and independent analysts and information providers (such as Platts or OPIS in the case of energy products). 

In addition, the Division of Enforcement (DOE) has a successful history of investigating and prosecuting energy cases. It currently has more than a dozen ongoing 

crude oil manipulation investigations. In the process of investigating energy cases, 

DOE trains its professionals on the various nuances of the market. Furthermore, 

in certain situations, DOE hires professional experts to assist in fully exploring both 

physical and derivative trading issues. 

In the other Divisions, staff work on a range of different market issues, including 

issues involving crude oil. Generally speaking, the CFTC employs a number of 

economists, surveillance experts, attorneys, enforcement investigators, and IT professionals who collectively work on crude oil market issues such as surveillance, new 

product approval, financial integrity, data gathering and analysis, and enforcement. 

Question 6. If CFTC believes that oil markets tightness alone justifies the current 

$100+ oil price, I would think that your organization must also believe that removing 70 thousand barrels per day from the market to add to the Strategic Petroleum 

Reserve is adding to upward price pressure. Could you tell us how much your organization believes the SPR fill is adding to the price of oil? 

Answer. Commission staff has not undertaken an analysis of the effect on the 

cash market for crude oil of removing 70 thousand barrels per day from crude supplies. The Commission’s exclusive jurisdiction and thus the primary focus of its regulatory activities centers on the trading of commodity futures and options, rather 

than the physical market. The CFTC’s mission is two-fold: to protect the public and 

market users from manipulation, fraud, and abusive practices; and to ensure open, 

competitive and financially sound markets for commodity futures and options. As 

part of our efforts to prevent manipulation, we monitor cash market information as 

part of our ongoing surveillance of futures markets, such as the NYMEX crude oil 

futures market. As a starting point for cash market information on crude oil, we 

typically look to the EIA. 

Question 7. It is my understanding that your organization has concluded that 

there is no relationship between increased market participation and increasingly 

volatile oil prices because you have not found a statistically-verified causal relationship. It strikes me that causality is very difficult to prove with statistics, and I suspect that no single variable could pass that test at the moment. Have you run similar kinds of statistical analyses on other single variables influencing oil prices—such 

as OPEC production decisions, or inventory levels—and compared the results? 

Answer. While I agree that statistically-verifiable causal relations can often be 

difficult to demonstrate, I am confident that OCE’s analysis is rigorous. Noisy data 

and small data sets often lead to low power tests—the idea that a test may not be 

able to uncover a relation that actually exists, for example. As I have noted, however, our tests have uncovered statistically verified relations between groups of commercial traders and price changes, suggesting to me that our analysis is thorough 

and accurate. We have also taken steps to ensure our conclusions are rigorous, 

measuring positions of various combined groups (all non-commercial participants 

lumped together, for instance) and measuring the relation between speculative positions and price changes over different time periods (ranging from the late 1990s 

through the present) and over various futures contracts (examining positions in the 

nearby contract alone, positions in the nearby contract and the next month contract 

combined, etc.). 

The CFTC’s mission is to oversee and regulate the trading of commodity futures 

and options in the U.S., and as such our focus and expertise is in that area. While 

we monitor inventory levels, spot market developments and other macroeconomic 

factors, our analysis has not included a similarly rigorous look at macroeconomic 

data. 

Question 8. Does your organization believe that it has sufficient oversight and regulatory authority to fully understand oil market trading activity? Can you have a 

complete picture of the market without data on trade in over-the-counter markets? 

Answer. As stated in testimony approved by the Commission and given before the 

Senate Homeland Security and Governmental Affairs Committee on May 20, 2008, 

‘‘The Commission has the authority it needs to continue to work to promote competition and innovation, while at the same time, fulfilling our mandate under the Commodity Exchange Act to protect the public interest and to enhance the integrity of 

U.S. futures markets.’’ 

80 

There are amendments to the CEA that are now part of the Farm Bill conference 

report that largely reflect the Commission’s recommendations on the need for some 

additional tools to oversee trading done on Exempt Commercial Markets, as well as 

the imposition of self-regulatory obligations on these markets. These provisions represent bipartisan efforts to find the right balance of enhanced market oversight and 

transparency while promoting market innovation and competition. Additionally, the 

Commission’s anti-fraud authority over the transactions on these markets will be 

clarified and strengthened. Finally, the penalties that may be imposed for violating 

the anti-manipulation prohibitions of the CEA will be raised from $100,000 to 

$1,000,000 per violation. The Commission strongly supports this legislation that 

would give it additional necessary oversight of the markets, particularly energy 

trading. 

The central focus of the Commission’s oversight of oil market trading activity is, 

by mandate of the Commodity Exchange Act (CEA), futures trading activity in oilrelated contracts on CFTC-regulated exchanges. The Commission does not have any 

direct regulatory authority over domestic or foreign oil cash markets, bilateral OTC 

oil derivatives transactions or oil futures contracts traded on foreign boards of trade. 

The CFTC’s ability to monitor oil futures contracts traded on CFTC-regulated 

markets, such as NYMEX’s benchmark West Texas Intermediate (WTI) crude oil futures contract, is extremely robust. Traders with positions in regulated exchange 

contracts like the WTI contract are subject to a daily reporting requirement when 

their positions exceed a Commission-set ‘‘large’’ position threshold. Large trader position reporting enables CFTC staff to detect whether such traders may be engaging 

in manipulative conduct. Current position reporting thresholds ensure that about 

85-90% of the outstanding open interest in any contract is subject to reporting. 

When the CFTC’s surveillance staff finds that a trader’s market behavior is troublesome, it has a number of available powers to correct the condition, including the 

forced liquidation of the trader’s position. 

In addition to large trader position reports, the Commission also receives daily 

transaction data from all of its regulated exchanges. This data provides a complete 

audit trail of all trades that occur in the contracts listed on those exchanges. The 

CFTC’s surveillance staff uses this data to closely scrutinize trading activity, especially during key trading periods such as the final trading day of a contract. 

Of course, with respect to oil products traded on CFTC-regulated exchanges such 

as NYMEX, the exchanges themselves have independent obligations, under Section 

5 of the CEA, to actively monitor their contracts for manipulation and other abusive 

conduct and to takes steps to prevent such behavior. Given their mutual obligations 

and interests in this area, staff of the Commission and the exchanges traditionally 

work very closely together and buttress each other’s efforts in deterring and detecting problematic conduct. 

Although the Commission does not have any direct regulatory authority over domestic or foreign oil cash markets, bilateral OTC oil derivatives transactions or oil 

futures contracts on foreign boards of trade, it does have tools that enable it to see 

a wide swath of activity in these markets. For instance, many bilateral OTC oil derivatives transactions are executed through voice brokers and brought to NYMEX’s 

Clearport facility for clearing. Because all positions cleared through Clearport are 

subject to the Commission’s large trader reporting requirements, the CFTC has a 

significant insight into who is holding large OTC oil derivatives positions at any one 

time. 

The Commission is likewise able to learn information about activity off of its regulated markets by virtue of the requirement that traders who are subject to the large 

trader reporting requirement in an exchange-listed futures contract, like the 

NYMEX WTI contract, must make available to the Commission, upon request, any 

pertinent information with respect to all other positions and transactions in the 

commodity in which the trader has a reportable position. This information can include, for instance, the trader’s positions on other reporting markets, OTC positions 

held pursuant to any of the CEA’s exemptive or excluding provisions, positions held 

on exempt commercial markets or exempt boards of trade, and positions held on foreign boards of trade. 

To the extent that a Foreign Board of Trade (FBOT) with direct access to USbased members lists any contract that settles off of the settlement price of a contract listed on a CFTC-regulated exchange, the Commission’s policy has been to establish information-sharing arrangements with that FBOT or its regulator to gain 

position information about the linked contract. For example, ICE Futures Europe 

trades a WTI crude oil futures contract that settles off the benchmark NYMEX WTI 

contract. Accordingly, the CFTC has an information—sharing arrangement with the 

UK’s Financial Services Authority (FSA) so that CFTC staff receives on a weekly 

basis position reports for the ICE Futures Europe WTI crude oil futures contract. 

81 

During the last week of trading, the position data is reported on a daily basis. With 

this information, CFTC surveillance staff knows the positions and identities of members/customers who meet or exceed position-reporting requirement levels in the ICE 

Futures Europe WTI contract, and considers that data along with the large trader 

reporting information that it receives from NYMEX for its WTI contract. 

Question 9. Could you comment on whether the reporting requirements for the 

NYMEX could offer a competitive advantage to trading platforms that are not similarly regulated—such as foreign exchanges, or over-the-counter markets? 

Answer. There is no indication that the reporting requirements for NYMEX offer 

a competitive advantage to trading platforms that are not similarly regulated. Reporting requirements are a necessary component of a good market surveillance program and are designed to prevent such problems as manipulation and artificial pricing. In October 2007, the Commission amended its Rule 18.05 to make explicit that 

‘‘reportable traders’’ in the regulated futures markets must disclose all their OTC 

positions, as well as their cash market and forward market positions, in response 

to a request from the Commission. See Maintenance of Books, Records and Reports 

by Traders, 72 Fed. Reg. 60767 (October 26, 2007). In doing so, the Commission asserted that it was highly speculative to conclude, and very unlikely, that market 

participants would move their trading activity to unregulated or non-transparent 

venues, or trade at a level below the reportable level on the regulated exchange, in 

order to avoid the consequences of holding positions that were reportable to the 

CFTC. The Commission also noted that as traders in the OTC markets have become 

more aware of credit considerations and the benefits of transparency, they have 

been moving their positions onto exchanges where the exchange clearinghouse enhances creditworthiness, the market is transparent and reporting requirements are 

in place. Finally, it should be noted that some FBOTs, including ICE Futures Europe (which is regulated by the FSA), also impose position reporting requirements. 

Therefore, we believe that it would be highly unlikely that a trader would elect to 

trade a futures contract on ICE Futures Europe rather than on NYMEX solely because of reporting requirements. 

RESPONSES OF JEFFREY HARRIS TO QUESTIONS FROM SENATOR DOMENICI

Question 1. In your testimony, there are several charts that reference trading on 

the New York Mercantile Exchange. Do you have any information or data on transactions occurring on the Intercontinental Exchange? 

Answer. Yes. Although the CEA does not currently provide for direct CFTC regulatory oversight over activity on exempt commercial markets (ECMs), such as the 

Intercontinental Exchange of Atlanta (ICE), the CFTC does have the ability to collect considerable information regarding trading activity on these markets. 

Under CFTC Rule 36.3, ECMs are required to provide the CFTC with transaction 

data for those contracts that average five or more trades per day. This required data 

is essentially a contract’s trade register reflecting the specifics of each trade executed in the contract, including the quantity, price and execution time for each 

transaction. This data must be provided to the CFTC by way of a weekly report reflecting the daily trading registers for the preceding week. CFTC staff currently receives trade register data for a number of contracts traded at ICE, as well as for 

contracts at other ECMs. 

In addition, the CEA provides the Commission with the authority to issue special 

calls to ECMs for certain purposes, including obtaining data that it deems necessary 

to enforce the anti-manipulation prohibition applicable to ECM transactions. In the 

case of ICE, the CFTC’s Division of Market Oversight has issued three special calls 

requiring ICE to provide ongoing information related to its cleared natural gas swap 

contracts that are cash-settled based on the NYMEX physical delivery natural gas 

contract. In each case, the information requested has been analogous to information 

that the CFTC receives from regulated futures exchanges, including NYMEX. 

As noted above, Congress recently approved the Farm Bill conference report 

which contains, among other things, legislative provisions recommended by the 

Commission to require large trader position reporting for significant price discovery 

contracts on ECMs, require ECMs to adopt position limits or accountability levels 

for such contracts, impose self-regulatory responsibilities on ECMs with respect to 

significant price discovery contracts and establish CFTC emergency authority over 

these contracts. We are hopeful that this legislation is enacted soon to give CFTC 

these additional and necessary authorities. 

Question 2. To what extent does different regulatory treatment of the U.S. futures 

exchange as compared to the over the counter market, contribute to higher crude 

oil prices? 

82 

Answer. The CFTC Office of the Chief Economist (OCE) analyzes some of the 

most comprehensive data available on trading in futures markets. Although there 

exists a large and robust market for over-the-counter trading in crude oil, the growing volume of trading on NYMEX suggests that U.S. futures exchanges are successfully offering contracts that are attractive to the marketplace. We find little evidence that changes in speculative positions are systematically driving up crude oil 

prices in these markets. Increased trading activity usually indicates a good level of 

liquidity in the marketplace. In turn, greater liquidity usually reflects more accurate 

prices. The OCE has no evidence that different regulatory treatment of exchangetraded futures contracts and OTC contracts leads to higher prices. Indeed, the U.S. 

regulatory structure in this area has remained largely unchanged during the past 

decade and yet oil prices have gone up, down and remained steady at various time 

during this period. 

Question 3. Can you quantify the number of commercial versus non-commercial 

investors in the trading of oil contracts? 

Answer. Yes, the Commission receives daily reports on all large traders in all regulated futures markets. For the NYMEX WTI Crude Oil futures contract, these reports account for about 97 percent of the long open interest and 96 percent of the 

short open interest. On April 22, 2008, there were 299 non-commercial traders in 

this market, who held 40 percent of the long and 35 percent of the short open interest, respectively. On this same date, there were 123 commercial traders, who held 

58 percent of the long and 62 percent of the short open interest, respectively. 

Question 4. he characteristics of the typical commodity investor are changing. In 

your opinion, do you think this is beneficial for the market? Why or Why not? And 

what impact has it had on the price of crude oil? 

Answer. Markets, in general, provide more accurate prices when participation is 

high. As noted above, increased participation usually indicates a good level of liquidity in the marketplace, which, in turn, typically generates more accurate prices. Indeed, the increased participation in crude oil futures markets has been a positive 

development in our ability to monitor and surveil these markets. The CFTC’s Division of Market Oversight (DMO) collects data on participant behavior precisely because we are concerned about the prospect for manipulation and other abuses in our 

markets. The addition of, or growth in, any group of market participants is closely 

monitored by CFTC staff in this light. The growth in commodity index trading in 

these markets has been largely mirrored by growth in commercial trading activity 

as well, and we continue to see a healthy mix of commercial and non-commercial 

activities in oil futures markets. Given the fact that we find little evidence that 

changes in speculative positions are systematically driving up crude oil prices in 

these markets, we see benefits but do not see corresponding negative implications 

of this growth. 

Question 5. What type of additional regulation, or oversight, of energy commodities trading would be the most damaging or most beneficial, to the interests of the 

U.S. consumer? 

Answer. Congress recently approved the Farm Bill conference report which contains, among other things, legislative provisions recommended by the Commission 

to give the agency additional regulatory and enforcement tools necessary to continue 

to effectively oversee the futures industry. Among other things, the legislation would 

provide the agency with essential oversight over contracts trading on Exempt Commercial Markets (ECMs)—a type of electronic trading facility offering (among other 

things) energy derivatives products. Under current law, ECMs are not subject to full 

CFTC regulatory authority. The new legislation outlines criteria for when an ECM 

contract should be considered a significant price discovery contract (SPDC) and 

gives the CFTC the authority to require large trader position reporting for SPDCs; 

require an ECM to adopt position limits or accountability levels for SPDCs; require 

an ECM to exercise self-regulatory responsibility over SPDCs in order to prevent 

manipulation (among other things); exercise emergency authority regarding SPDC 

transactions. We are hopeful that this legislation is enacted soon to give the CFTC 

these additional and necessary authorities. 

From my vantage point as the Commission’s Chief Economist, the futures markets 

are functioning as intended—to provide risk management and price discovery for 

market participants. Any policy that would adversely affect these critical functions 

may have unintended consequences harmful to consumers. Competitive and open future markets require both hedgers and speculators so that commercial interests can 

hedge their commodity price risks and businesses can rely on discovered prices to 

plan and commit resources as needed. 

Question 6. What regulatory policies need to be implemented to assure the competitive workings of energy derivative markets? 

83 

Answer. As discussed above, the CFTC is an independent agency with the mandate to regulate commodity futures and option markets in the United States. Broadly stated, the CFTC’s mission is two-fold: to protect the public and market users 

from manipulation, fraud, and abusive practices; and to ensure open, competitive 

and financially sound markets for commodity futures and options. The Commission 

utilizes a principles-based regulatory structure. We rely on self-regulation with rigorous federal oversight, which has a long history of ensuring properly functioning 

futures markets. Nevertheless, when abuses come to the attention of the Commission, they have been investigated and the appropriate enforcement actions taken. 

The Commission has very broad enforcement authority and during the past seven 

years the Commission has brought enforcement actions against Enron and BP, dozens of other energy companies, and more than one hundred energy traders. A list 

of cases filed by the Commission in the energy sector is attached. These cases were 

based on violations of the CEA ranging from manipulation to attempted manipulation and manipulative acts such as false price reporting. 

As noted above, Congress recently approved the Farm Bill conference report 

which contains, among other things, CFTC legislative provisions recommended by 

the Commission to require large trader position reporting for SPDCs on ECMs, require ECMs to adopt position limits or accountability levels for SPDCs, impose selfregulatory responsibilities on ECMs with respect to SPDCs, and establish CFTC 

emergency authority over these contracts. We are hopeful that this legislation is enacted soon to give CFTC these additional and necessary authorities. 

Question 7. Earlier this week the Secretary of Treasury, Henry Paulson put forth 

a proposal to combine the Securities Exchange Commission and the CFTC. Does the 

CFTC support or oppose this proposal? What impact if any would this proposal have 

on the commodity markets? 

Answer. The Commission has not issued a statement opposing or supporting the 

recommendations of the Secretary of the Treasury’s ‘‘regulatory blueprint.’’ 

CFTC Acting Chairman Walt Lukken has made the following statement in response to the blueprint: 

It is essential to examine ways to enhance the competitiveness of U.S. financial markets and seek improvements to the regulatory structure. Policymakers all strive for good government solutions that protect the public, reduce duplication and enhance competition and innovation. While I am still 

studying the Blueprint’s many recommendations, I applaud Secretary 

Paulson and the Treasury Department for their work on this critical undertaking and for recognizing the CFTC model of regulation as an advantageous one. 

The CFTC utilizes a flexible and risk-tailored approach to regulation 

aimed at ensuring consumer protection and market stability while encouraging innovation and competition. Congress gave the CFTC these powers 

with the passage of the Commodity Futures Modernization Act (CFMA) in 

2000, which shifted the CFTC’s oversight from a rules-based approach to 

one founded on principles. This prudential style is complemented by strong 

enforcement against market abuse and manipulation as evidenced by the 

$1 billion worth of penalties assessed by the CFTC since the CFMA. The 

regulatory balance fostered by the CFMA has enabled the futures industry 

to thrive and gain market share on its global competitors with volumes on 

the U.S. futures exchanges increasing over 500 percent since 2000. During 

recent economic stress, these risk-management markets have performed 

well in discovering prices and providing necessary liquidity. 

At this stage, it is somewhat preliminary to state what impact the proposal could 

have on the commodity markets. Notably, the blueprint recommends that the SEC 

adopt a principles-based regulation of securities exchanges and clearing organizations modeled after the CFTC’s principles-based approach, before contemplating 

combining the agencies. 

RESPONSES OF JEFFREY HARRIS TO QUESTIONS FROM SENATOR TESTER

Question 1. Oversight is only as good as the information available to the overseers. As the chief economist of the CFTC, do you have all the information necessary 

to ensure that speculators cannot significantly affect the price of oil, irrespective of 

the market it is traded on? If not, what can we do to make sure you have all the 

information you need? 

Answer. As stated in testimony approved by the Commission and given before the 

Senate Homeland Security and Governmental Affairs Committee on May 20, 2008, 

‘‘The Commission has the authority it needs to continue to work to promote competiVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00087 Fmt 6601 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
84 

tion and innovation, while at the same time, fulfilling our mandate under the Commodity Exchange Act to protect the public interest and to enhance the integrity of 

U.S. futures markets.’’ 

There are amendments to the CEA that are now part of the Farm Bill conference 

report that largely reflect the Commission’s recommendations on the need for some 

additional tools to oversee trading done on Exempt Commercial Markets, as well as 

the imposition of self-regulatory obligations on these markets. These provisions represent bipartisan efforts to find the right balance of enhanced market oversight and 

transparency while promoting market innovation and competition. Additionally, the 

Commission’s anti-fraud authority over the transactions on these markets will be 

clarified and strengthened. Finally, the penalties that may be imposed for violating 

the anti-manipulation prohibitions of the CEA will be raised from $100,000 to 

$1,000,000 per violation. The Commission strongly supports this legislation that 

would give it additional necessary oversight of the markets, particularly energy 

trading. 

The central focus of the Commission’s oversight of oil market trading activity is, 

by mandate of the CEA, futures trading activity in oil-related contracts on CFTCregulated exchanges. The Commission does not have any direct regulatory authority 

over domestic or foreign oil cash markets, bilateral OTC oil derivatives transactions 

or oil futures contracts traded on foreign boards of trade. 

The CFTC’s ability to monitor oil futures contracts traded on CFTC-regulated 

markets, such as NYMEX’s benchmark WTI crude oil futures contract, is extremely 

robust. Traders with positions in regulated exchange contracts like the WTI contract 

are subject to a daily reporting requirement when their positions exceed a Commission-set ‘‘large’’ position threshold. Large trader position reporting enables CFTC 

staff to detect whether such traders may be engaging in manipulative conduct. Current position reporting thresholds ensure that about 85-90% of the outstanding open 

interest in any contract is subject to reporting. When the CFTC’s surveillance staff 

finds that a trader’s market behavior is troublesome, it has a number of available 

powers to correct the condition, including the forced liquidation of the trader’s position. 

In addition to large trader position reports, the Commission also receives daily 

transaction data from all of its regulated exchanges. This data provides a complete 

audit trail of all trades that occur in the contracts listed on those exchanges. The 

CFTC’s surveillance staff uses this data to closely scrutinize trading activity, especially during key trading periods such as the final trading day of a contract. 

Of course, with respect to oil products traded on CFTC-regulated exchanges such 

as NYMEX, the exchanges themselves have independent obligations, under Section 

5 of the CEA, to actively monitor their contracts for manipulation and other abusive 

conduct and to takes steps to prevent such behavior. Given their mutual obligations 

and interests in this area, staff of the Commission and the exchanges traditionally 

work very closely together and buttress each other’s efforts in deterring and detecting problematic conduct. 

Although the Commission does not have any direct regulatory authority over domestic or foreign oil cash markets, bilateral OTC oil derivatives transactions or oil 

futures contracts on foreign boards of trade, it does have tools that enable it to see 

a wide swath of activity in these markets. For instance, many bilateral OTC oil derivatives transactions are executed through voice brokers and brought to NYMEX’s 

Clearport facility for clearing. Because all positions cleared through Clearport are 

subject to the Commission’s large trader reporting requirements, the CFTC has a 

significant insight into who is holding large OTC oil derivatives positions at any one 

time. 

The Commission is likewise able to learn information about activity off of its regulated markets by virtue of the requirement that traders who are subject to the large 

trader reporting requirement in an exchange-listed futures contract, like the 

NYMEX WTI contract, must make available to the Commission, upon request, any 

pertinent information with respect to all other positions and transactions in the 

commodity in which the trader has a reportable position. This information can include, for instance, the trader’s positions on other reporting markets, OTC positions 

held pursuant to any of the CEA’s exemptive or excluding provisions, positions held 

on exempt commercial markets or exempt boards of trade, and positions held on foreign boards of trade. 

To the extent that a Foreign Board of Trade (FBOT) with direct access to USbased members lists any contract that settles off of the settlement price of a contract listed on a CFTC-regulated exchange, the Commission’s policy has been to establish information-sharing arrangements with that FBOT or its regulator to gain 

position information about the linked contract. For example, ICE Futures Europe 

trades a WTI crude oil futures contract that settles off the benchmark NYMEX WTI 

85 

contract. Accordingly, the CFTC has an information-sharing arrangement with the 

UK’s Financial Services Authority (FSA) so that CFTC staff receives on a weekly 

basis position reports for the ICE Futures Europe WTI crude oil futures contract. 

During the last week of trading, the position data is reported on a daily basis. With 

this information, CFTC surveillance staff knows the positions and identities of members/customers who meet or exceed position-reporting requirement levels in the ICE 

Futures Europe WTI contract, and considers that data along with the large trader 

reporting information that it receives from NYMEX for its WTI contract. 

Question 2. Is there any practical reason that the Enron loophole should not be 

closed immediately? Is there any reason that oil futures should be exempted from 

any CEA requirements, irrespective of the market they are traded on? 

Answer. With respect to the first question: No. Adoption of amendments to the 

CEA contained in the Farm Bill conference report, recently approved by the House 

and Senate, will close what some have referred to as the ‘‘Enron Loophole. 

With respect to the second question: Oil contracts traded on regulated futures exchanges are subject to all the regulatory requirements outlined in the CEA. The 

CFTC amendments that are part of the Farm Bill conference report would require 

that any ECM contracts that serve a significant price discovery function be subject 

to regulatory requirements comparable to those that govern trades on CFTC-regulated exchanges. 

Question 3. Are there any tools or authorities that could be given to the CFTC 

to better enable your organization to ensure both that the price of oil reflects the 

true market signals of supply and demand, and that there will not be a significant 

over investment, in the form of an oil bubble, that could put our economy or energy 

security at risk? Is your organization sufficiently capable of preventing over speculation and future oil bubbles? 

Answer. As discussed above, the CEA amendments that are part of the Farm Bill 

conference report would significantly enhance Commission oversight over the trading of significant price discovery contracts on ECMs. The Farm Bill amendments 

would thereby strengthen market surveillance, and also include separate provisions 

that would enhance CFTC anti-fraud coverage and penalties. 

The CFTC has several tools in place to prevent ‘‘over speculation.’’ The Commission has utilized its authority to set limits on the amount of speculative trading that 

may occur or speculative positions that may be held in contracts for future delivery. 

The speculative position limit is the maximum position, either net long or net short, 

in one commodity future (or option), or in all futures (or options) of one commodity 

combined, that may be held or controlled by one person (other than a person eligible 

for a hedge exemption) as prescribed by a regulated futures exchange and/or by the 

Commission. 

In conjunction with CFTC efforts, the exchanges themselves have independent obligations, under Section 5 of the CEA, to actively monitor their contracts for manipulation and other abusive conduct and to takes steps to prevent such behavior. 

Given their mutual obligations and interests in this area, Commission staff and the 

exchanges traditionally work very closely together and buttress each other’s efforts 

in deterring and detecting problematic conduct. 

As part of its ongoing surveillance program, Commission staff monitor daily largetrader reports to ensure compliance with Commission and exchange position limits. 

In order to achieve the purposes of the speculative position limits, both the Commission and exchanges treat multiple positions on an exchange that are subject to common ownership or control as if they were held by a single trader. Accounts are considered to be under common ownership if there is a 10 percent or greater financial 

interest. The rules are applied in a manner calculated to aggregate related accounts. 

Question 4. Do you see increased trading of oil futures following events that may 

decrease the supply of oil, such as geopolitical events or natural disasters? Do these 

tend to be driven by the users/producers of oil or by the noncommercial investors? 

If they are driven by the noncommercial investors, would this be considered excessive speculation? 

Increased trading in oil futures markets does indeed result from fundamental supply and demand factors like natural disasters and geopolitical events. As risks increase around the world, commercial entities that rely on oil supplies extend their 

risk management operations further into the future. Recent research by the CFTC’s 

Office of the Chief Economist highlights the fact that crude oil futures contracts now 

trade out beyond 8 years, whereas the longest-term contracts in 2000 were only 4 

years in duration. Participation in these longer-term contracts indicates that commercial traders are looking to lock in future delivery prices in an uncertain environment. Furthermore, in our research, non-commercial traders (including hedge funds) 

were largely net sellers in contracts beyond 4 years, suggesting that non-commercial 

traders are not speculating that oil prices will rise further. 

86 

RESPONSES OF KEVIN BOOK TO QUESTIONS FROM SENATOR BINGAMAN

Question 1. Do you disagree that increased market participation of institutional 

investors and increased volatility of oil prices are correlated? 

Answer. I do not dispute the positive correlation between rising noncommercial 

volumes and increased volatility, but due to the nature and motivation of noncommercial trading, I do not think the correlation is sufficient to suggest a causal 

link and I would suggest that reverse causation is possible and even likely. Traders 

who participate in commodities markets are attracted to volatility. Entire classes of 

institutional investors pursue ‘‘special situations’’ characterized by risk and uncertainty as a way to diversify their funds under management away from conventional 

market moves. They may be pursuing the oil market with greater interest as a result of uncertainty and price volatility derived from non-financial events. 

Question 2. I’d like to explore your statement that many institutional investors 

see the current price as evidence of the theory that we have reached the global peak 

oil production capacity. This strikes me as somewhat circular, in the sense that institutional investors are pushing the oil price upward, and then seeing that price 

increase as evidence of tight fundamentals, which then pushes the price further upwards. Is it your sense that the institutional investors, on balance, believe that we 

have reached peak oil production capacity? How important is this perception in the 

current marketplace? 

Answer. You are correct, Senator, that I intended to suggest a circularity—investors responding to price signals by investing and, in turn, perpetuating price signals—because that is the nature of the feedback loop that can underlie market bubbles. Your questions are extremely prescient because they get to the heart of what 

investors do. Investors make money buying and selling securities, not underlying 

fundamentals. Sometimes it can be more important to short-term investors to know 

what the market will do next than it is to know what the underlying fundamentals 

of the market are, or should be. In investment parlance, those who argue fundamentals in the face of market dynamics are often said to be ‘‘fighting the tape’’—because 

the nature of free and open markets is that they can fall prey to mobs. I do not 

believe that many of the better-educated, more-experienced investors I serve are 

convinced we are at either a geological or logistical ‘‘peak’’ in global oil production, 

however, and many have expressed their reticence to reposition their portfolios as 

if this were the case. If more long-term, large-scale investors were convinced we had 

arrived at peak oil, I would suggest that the stocks of alternative fuels companies— 

ethanol producers, coal-to-liquids names, natural gas fueling services, as well as 

companies with advantages in alternative fuels, like Shell and ChevronTexaco— 

might have displayed tremendous appreciation relative to the market. This has not 

yet occurred. 

Question 3. You point out that oil is the most widely traded commodity in the 

world, as evidence that the oil market is not over-saturated. While it is certainly 

true that oil is the most actively traded commodity, it is also still a small fraction 

of the equities market. It seems to me that a small percentage of equities investment moving into commodity markets is still a lot of new activity for the commodity 

markets. Could you elaborate on why you believe that oil markets are not saturated? 

Answer. I offer the volume of oil trading as evidence of market complexity, not 

as a comment on its saturation. My view that the oil market is not oversaturated 

derives from the size of the market eight years into the future relative to its size 

today—the oil market can hold about 100 times more money than it currently does. 

The out years in the market are less widely invested than contracts with nearerterm expiry dates. My computation in preparation for the hearing was that the open 

interest in NYMEX crude had an average expiration of 11.59 months. Listed equities have far greater value than commodities, but it seems premature to conclude 

that wealth transfer from commodities will continue indefinitely. At higher prices, 

it gets more expensive to buy oil contracts. Selling out of stocks to generate those 

funds would cause prices of those stocks to fall. Before long, those cheaper stocks— 

some of which include reserves owned by investor-owned companies—might be better investments than crude itself, and funds flow could reverse. 

Question 4. How long do you see this strong relationship between the dollar and 

the price for oil remaining in tact? And, is it safe to say that this relationship would 

not be as strong without the proliferation of institutional investors in the oil market? 

Answer. I believe the inverse relationship between the U.S. dollar and oil futures 

is likely to continue as long as oil trades in dollars, for reasons that have much 

more to do with the investment needs of oil producers than the behaviors of noncommercial traders. Ultimately, the currency-adjusted value of oil sales must pay 

87 

the oil producer’s costs plus a reasonable return on investment. Middle-Eastern oil 

producers procure services, labor and products for related and supporting sectors of 

their economies in other currencies, including Euros and Pounds. They also continue 

to peg their native currencies to the U.S. dollar, not least because a large portion 

of their national wealth is held in dollars and dollar-denominated instruments. A 

falling dollar makes it more expensive for oil producers to produce oil and diminishes the value of their national wealth, ultimately encouraging producers to demand a higher price to maintain parity with expectations. I would not conclude that 

institutional investors necessarily accelerate the rise of crude vis-&-vis the dollar’s 

fall; slower demand and a weaker currency basket in Europe could lower producers’ 

indifference point at the same time that non-commercial traders sell oil futures. 

Question 5. Historically, we’ve become accustomed to thinking of high oil prices 

causing recessions. It seems that this time, we might well be seeing a recession 

that—through a weak dollar and weak financial markets—is causing high oil prices. 

In your opinion, would a more healthy U.S. economy, with a stronger currency and 

a lower risk of inflation, likely result in lower oil prices? 

Answer. The challenge of macroeconomic analysis of oil markets is the breadth 

of subject matter. I am no expert on government fiscal policy and would be hesitant 

to predicate my answer on the notion that a recession is causing high oil prices. In 

general, it is reasonable to believe that healthy economies consume more oil. On the 

other hand, it would be imprudent to discount the structural shift in consumer behaviors likely in the event of a sustained recession and full economic recovery. Drivers who feel the pinch of high prices now are likely, based on historical precedent, 

to switch into higher-efficiency cars when next they can afford to purchase them. 

Those cars might be on the road 10-15 years given the high quality of today’s fleet 

and the policy changes to fuel economy standards enacted by this Committee. In 

this case, you might see a growing economy with flat and potentially even declining 

oil demand. Whether or not this would offset demand in other regions of the world, 

however, remains unclear. Countries without market prices for energy often rely on 

subsidies to maintain civil order, and consumption would need to slow everywhere— 

a likely outcome of a recession that spreads from the U.S. to its trade partners, not 

a global recovery—for demand effects to bring prices down. 

RESPONSES OF KEVIN BOOK TO QUESTIONS FROM SENATOR DOMENICI

Question 1. Is there any benefit to the market for allowing non-commercial investors (speculators) to participate? Do they lead or do they follow? 

Answer. Non-commercial investors generally make transactions cheaper. At the 

theoretical extreme, without non-commercial dollars, either the buyer or seller of oil 

would either sign longer-term contracts or put more money into every transaction. 

Longer-term contracts would give market power to sellers in this time of scarcity 

and could lead to high prices even if oil and oil products demand slowed. Putting 

more money into every transaction (either because the oil seller would need to borrow money for operations rather than selling forward or because the oil buyer would 

need to put the money up front first) would increase the cost of transactions even 

if interest costs were the only factor (about a 5% surcharge at a 10% cost of capital 

and the 11.59 months’ average contract life, but potentially much, much more). As 

to your second question, speculation of any kind theoretically requires investors to 

‘‘lead’’ because they are betting on their expectations of the future, but many of 

those expectations can be informed by past performance—rightly or wrongly—so it 

would be fair to say that non-commercials both lead and follow. 

Question 2. What would happen to the price for oil if the ability of non-commercial 

investors to participate in the market was limited? 

Answer. I would expect the price to rise somewhat, but the effect would depend 

on the extent of the limits. My prior reply addresses the range of potential price 

effects at the logical extreme—somewhere between 5% cost of capital effect and perhaps a 100-fold price increase if each barrel sold today incorporated every noncommercial dollar (both ends of the range are unlikely). Any incremental change to 

the margin requirement or participation rules might produce subtle effects that 

might take anywhere from one year to eight years to play out given the extent to 

which the market is invested into the future. 

Question 3. Does the trading of oil derivatives benefit the American consumer, 

and if so, how? 

Answer. In my view, the American consumer benefits from oil derivatives trading 

in two principal ways. First, refiners can buy options for oil to hedge against price 

and supply disruptions. Second, oil sellers—many of whom are publicly traded companies—earn income from derivatives sales that pass through to common shareholders, including American consumers. 

88 

Question 4. Some analysts see financial flows continually moving from the stock 

market to commodity markets, seeking the best return at the lowest risk. If this 

is an accurate characterization of the futures market, to what extent does it raise 

the average price and volatility of crude oil? 

Answer. I echo the conviction that asset managers will always, in the long run, 

allocate investment capital to its highest-return, risk-adjusted use, but there are 

short-term limits to the merchantability of different classes of securities, and investors who are chasing returns in any one asset class—whether it be stocks in general, 

stocks of a certain type, bonds, venture investment, real estate or commodities— 

may discover that rising prices lower returns and uncertain ‘‘exit’’ windows make 

the commodities markets unattractive for more than a small portion of their funds 

under management. 

RESPONSES OF KEVIN BOOK TO QUESTIONS FROM SENATOR TESTER

Question 1. Oil has become essential to our everyday lives, our economy and our 

security. Should national security concerns be considered in how oil is regulated and 

managed? Do you have any concerns with oil becoming the new gold? 

Answer. While I appreciate the ways in which oil and gold are similar—as a currency-neutral repository for wealth—I do not think the analogy holds in scale or 

scope. Gold has valid industrial applications for electronic circuits, but derives its 

scarcity premium from its value as a precious metal. Oil is useless to most of the 

world in its raw form—only refiners of oil can typically extract value for themselves—and it takes 420 gallons of oil to add up to a single ounce of gold at today’s 

prices. As a result, I would expect that most of the world’s wealthiest people will 

probably prefer to keep gold in the safe deposit box and the vault, rather than oil. 

Moreover, oil’s importance to economic security derives from its availability, not 

its scarcity. The greatest risk the U.S. economy can suffer is a supply interruption 

severe enough to prevent transportation and industrial activities from occurring. 

Sudden price changes are also disruptive, but only for the short term. Over the long 

haul, the U.S. economy is one of the best positioned purchasers of crude oil at any 

price as long as it is available to markets. As global markets become better supplied 

and better managed, U.S. wealth becomes its own form of energy security. The best 

hedge against unanticipated events remains the U.S. Strategic Petroleum Reserve, 

followed closely by aggressive conservation strategies, alternative fuels programs 

and end-user education. 

Question 2. If speculation is found to be artificially inflating the price of oil, what 

can we do to reduce this? In your opinion, is the CFTC sufficiently capable both of 

regulating all markets on which oil futures are traded to ensure speculation is not 

affecting the price of oil and of acting quickly and effectively when problems arise? 

Answer. The Committee rightly identified one of the ‘‘throttles’’ that control how 

funds flow into and out of the commodities market—the margin requirements imposed on traders. To the extent that price levels and volatility occasion a regulatory 

response, I believe existing CFTC powers are adequate and, in the event the current 

language of the Senate Farm Bill passes into law, likely to be augmented to include 

reporting on positions on the Intercontinental Exchange. To your second question, 

I would offer a somewhat cautionary response: the greater the regulatory burden 

imposed on any market, the higher the transaction costs associated with trading on 

that market. As the world continues to globalize outside of the reach of U.S. regulation, I would urge this Committee and its peers to be careful not to drive commerce 

outside the U.S. to less-well-regulated, less free, less open markets. 

RESPONSES OF SEAN COTA TO QUESTIONS FROM SENATOR BINGAMAN

Question 1. Do you disagree that increased market participation of institutional 

investors and increased volatility of oil prices are correlated? 

Answer. Increased market participation of institutional investors and increased 

volatility of oil prices are correlated. As an ever increasing number of non-commercial investors enter the market to buy commodities as an inflation hedge against the 

weak dollar, the demand for commodities increases which results in increased volatility and excessively high prices. The weak dollar tends to raise prices for commodities denominated in that currency. They become relatively cheap for non-dollar buyers and offer investors, such as hedge funds, a way to hedge themselves from any 

further weakening of the U.S. Dollar. Until the dollar appreciates against other currencies, we will continue to see investors flock to U.S. commodities, and their continued investment in commodities will only serve to further dislocate the cost of energy 

from the very economic fundamentals to which the markets were intended to look 

for direction. 

89 

Currently, there is no regulatory authority or federal law that would limit the 

amount of money flowing into energy commodities from non-commercial investors. 

That is why the New England Fuel Institute (NEFI) and the Petroleum Marketers 

Association of America (PMAA) are looking at possible increases in margin requirements for non-commercial investors to pay up-front before they enter into futures 

contracts. Stock market investors generally are required to keep more cash in margin accounts (around 50%) whereas futures investors only post margins between 5– 

7%. 

Question 2. I understand that your operating costs are substantially increased, 

and that holding inventory is much more expensive in this high price environment. 

But could you explain to us why you don’t simply pass on the cost to consumers? 

Why does this affect your margins so strongly? 

Answer. Several reasons, some competitive, some due to the lack of sophistication 

of the small businesses that make up the industry, and some are due to the increased underwriting requirements of banks. 

The retail petroleum industry marks up product on a cents per gallon basis, not 

on a percentage basis. As prices have doubled or tripled, the margins as a percentage have gone down dramatically. On a cents per gallon margin basis, other costs 

have increased and retailers are slow to recognize them. These expenses include: 

• Diesel and other transportation costs have risen and do not show up until after 

the sales to the consumer have occurred. The average dealer has one day supply 

of fuel, and these costs appear later. 

• Credit limits with suppliers have not increased, yet cost (heating oil specifically 

but others are similar) have gone from around $1.00 per gallon in 2004 to 

around $3.50 currently. Limits which allowed payment in 30 days are now 

reached in 10 days or less. This requires increased Lines of Credit with the local 

banks and the corresponding increased costs. 

• As prices are increasing, it is taking longer for customers to pay for the fuel, 

further increasing credit line requirement needs. 

• Customers are running out of disposable income, and are increasingly using 

their credit cards for payment. This cost is another 10 cents per gallon which 

is often not accounted for in the dealer margins. It also increases the cost of 

credit card transaction fees, a major burden for petroleum marketers, as mentioned in testimony by fellow panelist John Eichberger from the National Association of Convenience Stores. 

• Wholesale prices to dealers today change as much as 3 times per day. Dealers 

often deliver products at higher cost without the corresponding increase to consumers because they do not know what the cost is until after the sale occurs. 

• Dealer competition further erodes margin as dealers are reluctant to increase 

prices in our very competitive marketplace. Our segment of the energy market 

(retail heating fuel and motor vehicle fuel dealers) is the only one with direct 

contact with the consumer. Consumers complain, and fuel dealers (wrongly) are 

reluctant to pass along the increased costs. Finally, at a time when dealers need 

to rely on their banks more, banks are more rigorous with their underwriting 

for loans. 

These are just some of the reasons why margins are affected, and why the consumer will continue to see increases in costs even if and when prices begin to stabilize. 

RESPONSES OF SEAN COTA TO QUESTIONS FROM SENATOR DOMENICI

Question 1. How much of the recent $100-plus oil prices we have been seeing can 

be contributed to speculation? 

Answer. While there is much debate on the actual percentage or dollar amount 

per barrel or per gallon that can be attributed to what I term the ‘‘speculative premium,’’ it is clear that the numbers are significant. This is the general consensus 

of a majority economic analysts and market experts, including OPEC and major 

American oil companies (as evidenced by Exxon-Mobil’s statements before the House 

of Representative’s Select Committee on Energy Independence and Global Warming, 

only days prior to my own appearance before your committee). 

I’ve have come to the conclusion that excessive speculation on energy commodity 

markets have excessively driven up the price of crude oil (and, consequently, all refined petroleum products) without the supply and demand fundamentals to justify 

the recent run-up from about $50-60 dollars per barrel in early 2007, to over $110 

today. We have now moved beyond the previous inflation adjusted high of $104 in 

1979, but without an equivalent disruption to oil availability that was experienced 

during that decade. The numbers don’t add up. 

90 

However, to be able to accurately ‘‘add up’’ all of the numbers, you must have full 

market transparency. Unfortunately, this is perhaps the biggest barrier to obtaining 

an accurate percentage calculation of the per barrel cost of non-commercial speculative investment in crude oil, natural gas and other energy products. As I mentioned 

in my testimony, much of the non-commercial involvement in the commodities markets is isolated to the over-the-counter markets and foreign boards-of-trade, which, 

thanks to a series of legal and administrative loopholes, are virtually opaque. The 

U.S. Congress needs to work urgently to remedy this issue and bring full transparency to all trading environments. 

Several other energy analysts and national trade ground and consumer groups 

have agreed with the above and are asking for margin increases. According to Fadel 

Gheit, Managing Director and Senior Oil Analyst at Oppenheimer & Co. Inc., who 

testified before the Senate Committee on Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations at the hearing entitled, ‘‘Speculation in the Crude Oil Market,’’ stated that ‘‘Oil prices were close to $60 in August 

2007 and rose sharply to almost $100 in November 2007, although there were no 

changes in world oil supply or demand. Oil price volatility has attracted a large and 

growing number of speculators seeking the highest profit in the shortest time. Volatility, however, has an adverse impact on the oil industry because it increases uncertainty, and distorts market fundamentals, which could result in poor investment 

decisions in securing adequate reliable supply to meet global energy demand.’’ 

Question 2. In your testimony you mention legislation that Congressman John 

Larson introduced, which would eliminate non-commercial investors in the commodities market. Do you support this legislation? 

Answer. While NEFI and PMAA support efforts to rein in the excessive speculation in order to level the playing field between non-commercial and commercial players, we are still considering Congressman Larson’s (D-CT) proposal. NEFI and 

PMAA’s goal is to minimize the role of non-commercial investors in energy commodity markets and return the market power back to the physical players. Congressman Larson’s efforts should be further analyzed by a bi-partisan commission 

or a non-partisan agency (such as the GAO) so that Congress obtains the necessary 

information to formulate effective policy solutions. 

Question 3. In your testimony, you discuss regulatory gaps. What regulatory policies do you believe need to be implemented to assure the competitive workings of 

energy derivative markets, including those that are not regulated under the Commodities Exchange Act? 

Answer. First and foremost, Congress must pass the 2007 Farm Bill (H.R. 2419) 

which includes a very significant amendment added by unanimous consent in the 

Senate, the ‘‘Commodity Futures Trading Commission (CFTC) Reauthorization Act 

of 2008’’ (Title XIII). The legislation is an accumulation of numerous studies done 

by the Senate Permanent Subcommittee on Investigations, the Presidential Working 

Group on Financial Markets (PWG) and input from the CFTC’s Commissioners, energy commodity exchanges, market participants, energy consumers and members of 

our coalition. 

Secondly, revisit the use of the so-called, ‘‘no-action letters,’’ issued by the CFTC 

which allows foreign boards of trade (FBOT) to virtually circumvent U.S. regulatory 

policy. NEFI and PMAA are especially concerned that the current no-action letter 

process may have opened a door to domestic exchanges and financial interests looking to trade U.S. Commodities overseas with the intent of circumventing U.S. federal oversight. According to Michael Greenberger, who was previously the Director 

of the Division of Trading and Markets at the CFTC from September 1997 to September 1999, the ‘‘FBOT no action process was initiated for exchanges that were organized and operated in foreign countries. It was never intended for the no action 

process to apply when foreign exchange obtaining no action FBOT status is bought 

by a U.S. entity; operated in the U.S. with trading engines in the U.S.; and with 

U.S. delivery contracts being traded on that exchange. This is now the trading exemption the Intercontinental Exchange (ICE) based in Atlanta, Georgia is operating 

with U.S. trading engines in the U.S. while trading, inter alia, West Texas Intermediate crude oil contracts.’’ ICE is essentially regulated by the U.K. Financial 

Services Authority’s regulatory requirements which are generally believed by Michael Greenberger to have lax regulatory policy as compared to CFTC’s regulation 

of exchanges and transactions. 

Congress should revisit the use of no-action letters by the CFTC. It should determine if legislative correction is necessary in order to bring full transparency and accountability to FBOTs that trade U.S. destined commodities and/or allow U.S. access to their platforms. It should especially examine existing no-action letters to determine if any need be withdrawn in order to preserve stability in the energy markets and in order to protect the American consumer and the economy at-large. 

91 

Question 4. What type of commodities trading oversight, would be the most damaging or most beneficial, to the interests of the U.S. Consumer? 

Answer. The most beneficial type of commodities trading oversight for the interests of the U.S. Consumer would be to restore the authority to the CFTC before the 

passage of the Commodity Futures Modernization Act (CFMA) of 2000 (Public Law 

10-554). NEFI and PMAA consider the definition of ‘‘Enron Loophole’’ to be the collective statutes found in this law that aim to exempt energy commodities from portions of the act and deregulate energy trading. 

Of most concern are the following: 

• 7 U.S.C. §1(a)(14) which defines energy and metals as ‘‘exempt commodities.’’ 

• 7 U.S.C. §2(d)(2), (h)(3) and (g), exempt most over-the-counter energy derivatives trades, trading on electronic energy commodities markets and energy 

swaps. 

Additionally, as mentioned above, Congress should review CFTC Regulation 

140.99, setting forth the requirements for issuance of no-action letters and other letters of exemption and interpretation. Congress should also evaluate existing no-action letters for withdrawal, as mentioned in the prior answer. 

It is our belief that full transparency and accountability requirements, such as 

those that apply to traditional markets like NYMEX, should apply to all trading environments. What is good for NYMEX is good for ICE, and all OTC and derivatives 

exchanges. 

RESPONSES OF JOHN EICHBERGER TO QUESTIONS FROM SENATOR BINGAMAN

Question 1. Are there any panelists who disagree that increased market participation of institutional investors and increased volatility of oil prices are correlated? 

Answer. I am not a crude oil market analyst and NACS does not focus its research on the upstream side of the business, therefore my ability to accurately answer this question is severely limited. I can say that if reports are true and investors are indeed shifting their portfolios to the commodities market to offset the risks 

inherent in the stock and bond markets, this influx of capital would have an inflationary effect on the price of those commodities. However, I am not qualified to 

make a definitive cause and effect correlation regarding the actual observed behavior of the crude oil market. 

Question 2. I understand that your operating costs are substantially increased, 

and that holding inventory is much more expensive in this high price environment. 

But could you explain to us why you don’t simply pass on the cost to consumers? 

Why does this affect your margins so strongly? 

Answer. Retailers would like nothing more than to pass on to their customers any 

additional costs incurred in the system. However, competition makes this increasingly difficult. Today’s consumer is acutely aware of retail prices and aggressively 

shops for the best available price. 

According to a national survey of more than 1,200 individuals conducted on behalf 

of NACS between December 2007 and January 2008, 73% of consumers say that 

price is the most important factor when selecting a retailer from which to buy gasoline. In addition, a sizeable portion of consumers will inconvenience themselves to 

save money on gasoline: 32% will turn left across a busy intersection for 1 cent per 

gallon and 29% will drive 10 minutes out of their way to save 3 cents. 

According to the NACS State of the Industry reporting financial performance for 

2006, motor fuel sales generated two-thirds of a store’s revenues but comprised only 

one-third of gross margins. Sales of in-store items, like coffee and sandwiches, are 

the primary profit center for a convenience store. To generate sufficient sales inside 

the store, a convenience store must generate sufficient customer traffic. This necessitates competitive prices at the pump. Retailers are constantly under-pricing one 

another in an effort to generate greater customer volume with the hopes of selling 

them more items from inside the store. 

Competitive pressures determine what price a retailer may charge for motor fuel 

and still generate sufficient customer volume. Meanwhile, costs determine a retailer’s profitability at the pump. Yet costs can be very different for every retailer and, 

consequently, the motor fuel margin required to sustain a business model can likewise be quite different. For example, one retailer may experience an increase in 

wholesale costs of 10 cents per gallon while his competitor’s costs increased only 5 

cents. Further, each retailer may receive deliveries at different times of the week, 

thereby exposing each to different wholesale costs (wholesale prices often change 

several times in one day). Rents and lease terms for each retailer may be different, 

as might the strength of their inside the store sales, each of which would affect the 

92 

break-even calculations on the motor fuel business. Each of these variations in cost 

structure between competing retailers affects their competitive positioning in the 

market and potentially compromises their ability to pass through increases in cost 

while remaining sufficiently competitive in motor fuels prices to attract the requisite 

number of customers. 

RESPONSES OF JOHN EICHBERGER TO QUESTIONS FROM SENATOR DOMENICI

Question 1. Can you explain why the price of gasoline did not track oil prices in 

the last quarter of 2007? Crude oil prices increased by $29 per barrel or the equivalent of $.69 cents a gallon but gasoline prices have increased by $.32 cents per gallon or by half as much. Can you explain the disconnect here, especially when we 

are seeing the opposite trend since the beginning of the year, when gasoline prices 

increased by a greater percentage than crude oil prices? 

Answer. According to the U.S. Energy Information Administration, the retail price 

of gasoline can be broken down into four components: crude oil, taxes, refining, and 

distribution/marketing. The follow chart replicates EIA’s reported data: 

Retail Price Crude Oil Taxes Refining Dist/Mktg 

July 2007 $2.965 56.8% 13.4% 18.4% 11.4% 

August 2007 $2.786 60.4% 14.3% 13.5% 11.8% 

September 2007 $2.803 64.3% 14.2% 12.8% 8.6% 

October 2007 $2.803 67.6% 14.2% 10.1% 8.1% 

November 2007 $3.080 68.3% 13.0% 10.0% 8.7% 

December 2007 $3.018 68.1% 13.2% 8.1% 10.5% 

January 2008 $3.043 67.9% 13.1% 7.8% 11.1% 

February 2008 $3.028 69.7% 13.2% 9.9% 7.2% 

March 2008 $3.244 71.8% 12.3% 8.0% 7.9% 

As can be seen, the refining sector’s contribution to the retail price of gasoline 

during the last half of 2007 diminished greatly while the contribution of crude oil 

escalated. This was largely the reason why retail prices remained relatively stable 

during this six-month period—profitability at the refining level was diminishing. 

Consequently, wholesale prices for gasoline were not tracking upwards with crude 

oil because most of these raw material costs were being absorbed at the refinery. 

It is not reasonable to expect that any corporation could continue operations while 

sustaining diminishing returns, especially not in the long-term. By the beginning of 

2008, the decline in the refining sector’s contribution to the retail price of gasoline 

stabilized. Meanwhile, wholesale prices for gasoline began to climb at the beginning 

of February. One can look at data reported by the Oil Price Information Service for 

insight into what has happened thus far in 2008. 

National Average 

Wholesale Price* 

National Average 

Retail Price 

National Average 

Retail Gross Margin 

January 7, 2008 $2.514 $3.078 $0.096 

January 14, 2008 $2.417 $3.074 $0.189 

January 21, 2008 $2.327 $3.016 $0.222 

January 28, 2008 $2.340 $2.983 $0.176 

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National Average 

Wholesale Price* 

National Average 

Retail Price 

National Average 

Retail Gross Margin 

February 4, 2008 $2.383 $2.976 $0.126 

February 11, 2008 $2.341 $2.954 $0.146 

February 18, 2008 $2.444 $2.992 $0.081 

February 25, 2008 $2.560 $3.112 $0.083 

March 3, 2008 $2.573 $3.153 $0.111 

March 10, 2008 $2.613 $3.195 $0.112 

March 17, 2008 $2.682 $3.269 $0.115 

March 24, 2008 $2.629 $3.257 $0.156 

March 31, 2008 $2.708 $3.268 $0.090 

Change: + $0.194 Change: + $0.190 Average: $0.131 

* OPIS Rack prices do not include taxes and freight. 

The wholesale price of gasoline has increased to the same degree as has the retail 

price of gasoline, although not always on the same schedule as can be seen looking 

at the volatility in retailer gross margins over the first quarter of 2008. Part of the 

reason for the increased price at wholesale could be found by analyzing the trends 

in EIA data which show that the refining sector’s contribution to the retail price 

of gasoline stopped its downward spiral in 2008, thereby more completely transferring increases in the price of crude oil to the wholesale price of gasoline. 

It is also instructive for Congress to consider the annual cycle of gasoline prices 

when considering the influences on the current market. NACS has been tracking the 

retail price of gasoline on a weekly basis since January 2000, using data reported 

by EIA. Analyzing this data, one can identify certain times throughout the year during which retail prices have historically escalated. One of these periods is February 

through June, during which time the motor fuels supply transitions from winterspecification fuel blends to summer-specification blends. 

In the winter, gasoline is formulated with a higher evaporative tendency. This 

makes it easier for vehicles to start in the cold winter months. In the summer, however, these fuel formulations combine with warmer weather to contribute to the formation of smog. Therefore, in the summer months, the evaporative nature of gasoline (measured in terms of Reid Vapor Pressure and expressed as volatility) must 

be reduced. This requires refiners to remove additional components from their gasoline blends, leading to fewer gallons available from each barrel of oil and a higher 

cost of production. 

In February, refineries begin the process of drawing down winter-blend fuels, 

which typically can’t be delivered to wholesale outlets after May 1. (Some fuel 

blends are required weeks or months earlier, further complicating the system.) To 

accommodate these deadlines, refiners must estimate fuel needs months in advance 

and begin producing the more expensive summer-grade gasoline in February. Consequently, any unexpected increase in demand can significantly decrease the supply 

of winter-grade gasoline, causing the retail price of gasoline to increase while stocks 

of the more expensive summer-grade gasolines are built up. 

The duration and the severity of the spring price increase has varied over the past 

eight years. Between 2000 and 2006, prices increased an average of 30-plus cents 

each spring from early February to the seasonal peak. In the past two years, increases in crude oil prices have likely contributed more to the retail price than has 

the spring transition and separating the two is very difficult. However, during the 

time frames in question the retail price of gasoline has increased $0.707 in 2006 and 

$1.044 in 2007. 

Understanding how environmental policy, such as that establishing seasonal volatility standards, affects the production and supply of motor fuels is important when 

considering the overall performance of the market. 

94 

Question 2. In your testimony, you state that the price of crude oil is a significant 

factor in the retail price of gasoline and that consumers feel the pressure of higher 

gasoline prices. In your opinion what is the key to making gasoline prices cheaper? 

Answer. Regardless of external influences, economics dictates that when supplies 

for any object are greater than the relative demand, prices will decline. For years, 

retailers have been constant advocates for more plentiful and fungible motor fuel 

supplies. NACS led the charge to stop the further proliferation of boutique fuels because the resulting patchwork of fuel regulations inhibited the efficient distribution 

of fuels to market, thereby increasing costs. There are several examples in which 

additional supplies have mitigated increasing prices. Three such examples include: 

• When the fuel additive MTBE was removed from the gasoline pool in the spring 

of 2006 and the reformulated gasoline markets on the eastern seaboard had to 

switch to ethanol, there was not enough supply in that particular market at 

that particular time and ethanol prices spiked to more than $200 per barrel on 

the spot market. An influx of Midwestern and Brazilian ethanol offset the supply shortage and prices came back down. 

• In the aftermath of Hurricanes Katrina and Rita, the Environmental Protection 

Agency utilized its newly authorize authority to waive certain regulations concerning on-road diesel fuel. This successfully increased supplies and mitigated 

price spikes, keeping America’s trucks on the road. 

• Also in the aftermath of Hurricanes Katrina and Rita, the rapid escalation of 

retail gasoline prices resulted in a substantial increase of imported gasoline 

from Europe and other locations. The surge in imports helped balance supplies 

with demand and put downward pressure on retail prices. 

If substantial inventories of additional crude oil were brought onto the market, 

despite the non-commercial activities in the commodities exchanges, I believe that 

prices would begin to withdraw from their highs. Furthermore, if additional supplies 

were to have a dampening effect on prices, it is conceivable that non-commercial investors would begin to transfer their capital away from the crude oil commodities 

market and invest in markets with more favorable economic indicators for long-term 

return. 

The United States Congress must consider opportunities to increase the physical 

supply of transportation fuels. The Energy Independence and Security Act of 2007 

created a bold program to require the use of 36 billion gallons of renewable fuels. 

This is a component of the solution, but even with revolutionary developments in 

the production of these renewable fuels, petroleum-based fuels will continue to be 

the primary energy source for the United States for the foreseeable future and policies must not discount this fact. 

The market will respond to additional supplies of transportation fuels, but it will 

respond more quickly to additional supplies of transportation fuels which are compatible with the existing distribution infrastructure. The more investment required 

to accommodate a new fuel product, the slower and more costly will be its adoption 

by the market. Congress would do its constituents a great service by focusing its 

efforts on promoting the availability of fungible and compatible transportation fuels. 

This can be and should be done concurrently with efforts to develop and market the 

next generation of energy sources. 

RESPONSES OF SARAH EMERSON TO QUESTIONS FROM SENATOR BINGAMAN

Question 1. Do you disagree that increased market participation of institutional 

investors and increased volatility of oil prices are correlated? 

Answer. No, I agree that the increased market participation of institutional investors has contributed to crude oil price strength in the futures markets. Under a 

strict definition of price volatility (frequency of price changes), I am not certain that 

the institutional investors have specifically influenced volatility. 

Question 2. You note that ‘‘the physical oil market has not discouraged or disciplined investors . . . ’’ I agree with this statement, and believe that OPEC has 

failed to calm markets to the maximum extent of its ability. Could you talk to us 

about why OPEC might not be making a concerted effort to calm markets, as it has 

done in the past? 

Answer. OPEC’s ability to calm markets is limited by all the other bullish factors 

affecting price. With tight capacity all through the supply chain, any disruption or 

event related to oil markets is interpreted in a bullish manner. OPEC adding crude 

to the market to soften prices does not have the significant impact it had back in 

the 1980s and 1990s when spare capacity in the supply chain made the entire market more sensitive to supply increases. In other words, from a supply/demand point 

95 

of view, there was more downside price risk in the past than there is today. So, for 

OPEC to calm the markets today they would have to embark on a significant campaign to soften markets, raising production significantly and discounting their 

prices. At this point, there is not enough consensus in OPEC to embark on this campaign. That lack of consensus is in part because OPEC is worried about a recession 

in the US and more broadly in the rest of the world. They don’t want to add crude 

to the market if demand is slowing down. I think it is clear that there are differences of opinion within OPEC as to the optimal price level. Some countries are 

very concerned that the high prices will destroy demand. Other countries with more 

pressing fiscal requirements are less concerned about the long term impact on demand and alternative fuels of high prices. The other point to keep in mind is that 

the majority of OPEC crude oil is medium sour quality and yet the growth in demand is in clean sweet transport fuels, so additional OPEC crude does not provide 

a substitute for WTI which is a light sweet crude oil. As a result, additional OPEC 

crude is helpful to the degree that it can go through the sophisticated refiners of 

the world to make the clean petroleum products. That’s not to say additional OPEC 

crude isn’t helpful, it just has more of an arm’s length impact on light sweet oil 

prices on the futures exchanges. 

Question 3. You refer to government policy as an unknown variable that will affect future oil prices. Is it reasonable to predict that government policy success in 

reducing U.S. oil demand—reaching what Mr. Book referred to as our ‘‘peak appetite for oil’’—would lead to downward pressure on oil prices? 

Answer. To the degree that we can slow our demand growth for transportation 

fuels, we would remove a significant component of global oil demand growth (not 

withstanding the current slowdown in economic growth and oil demand). Oil demand growth would be concentrated in Asia and the Middle East. Oil prices would 

be weaker than if we did nothing and our economy would be more insulated from 

oil prices. 

Question 4. How long do you see this strong relationship between the dollar and 

the price for oil remaining in tact? And, is it safe to say that this relationship would 

not be as strong without the proliferation of institutional investors in the oil market? 

Answer. I do not have any idea how long this will last, but as the Fed continues 

to lower interest rates and the US economy slows, it is hard to see any reason for 

the dollar to strengthen, so I believe we are stuck in the current mutually-reinforcing situation between the weak dollar and strong oil for some time to come. 

Question 5. Historically, we’ve become accustomed to thinking of high oil prices 

causing recessions. It seems that this time, we might well be seeing a recession 

that—through a weak dollar and weak financial markets—is causing high oil prices. 

In your opinion, would a more healthy U.S. economy, with a stronger currency and 

a lower risk of inflation, likely result in lower oil prices? 

Answer. Absolutely, we are at today’s situation in part because our economy is 

suffering in so many different ways. A healthy economy and a stronger dollar might 

remove this investor desire to hedge against inflation by buying commodities. 

RESPONSES OF SARAH EMERSON TO QUESTIONS FROM SENATOR DOMENICI

Question 1. As you know, China is experiencing double-digit gross domestic product growth on a consistent basis. The 2004 economic surge in that country brought 

on a tangible significant rise in oil consumption at a pace unexpected by oil producers. What impact has this economic growth had on the price of global 

commodities... specifically oil? 

Answer. China’s oil demand growth has been striking, although it has moderated 

from 2004 levels. That growth coupled with China’s building and filing its own SPR 

has absolutely contributed to strong demand for oil, but we have seen other periods 

in history when global oil demand has grown faster than the last couple of years 

and prices have not risen this high. China is a medium sized piece of the puzzle. 

There are many other factors that are also contributing to the strong oil prices. 

Question 2. To what extent is the falling value of the U.S. dollar contributing to 

keeping the price of crude oil high? 

Answer. I believe this has been a significant factor since late summer/early fall 

2007 and continues to be a factor which keeps institutional investors interested in 

commodities (inc. oil) and will continue to do so for the foreseeable future. 

Question 3. What would be the likely effects on the U.S. economy and financial 

markets if the crude oil transactions took placed in a different currency? 

Answer. This would add one more layer of complexity to pricing and given the 

weak dollar would most likely increase the cost of oil to Americans because, in essence, we would have to buy euros (or Yen, etc) to buy oil and our realized price 

96 

would reflect not only the cost of the oil but the cost of the euro. On the other hand, 

this would also increase the cost of oil to everyone else in the world who has been 

buying cheap dollars to buy oil. To the degree that higher costs accelerate a slowdown in oil consumption elsewhere, oil prices might actually drop in the global market. This could yield benefits for the American economy. But this is a truly complicated question. Defining the overall impact on the US economy is difficult. 

Question 4. To what extent are Japan and Europe, countries with major currencies, protected from increases in the price of oil, and is this protection likely to 

result in major changes in competitiveness that might damage the U.S. economy? 

Answer. Any country, against whose currency the dollar weakens, benefits when 

they buy a dollar denominated good such as oil. So, they absolutely benefit from 

having currencies stronger than the dollar and this must enhance their competitiveness. On the other hand, US exports are cheaper and that enhances our competitiveness. Again it is difficult to define the overall impact of stronger currencies in 

other countries. 

RESPONSES OF SARAH EMERSON TO QUESTIONS FROM SENATOR TESTER

Question 1. If speculation is found to be artificially inflating the price of oil, what 

can we do to reduce this? In your opinion, is the CFTC sufficiently capable both of 

regulating all markets on which oil futures are traded to ensure speculation is not 

affecting the price of oil and of acting quickly and effectively when problems arise? 

Answer. I do not have enough knowledge of the CFTC’s activities, structure or 

mandate to comment on their capabilities. 

Question 2. Oil has become essential to our everyday lives, our economy and our 

security. Should national security concerns be considered in how oil is regulated and 

managed? Do you have any concerns with oil becoming the new gold? 

Answer. I do not equate oil with gold. Oil is a strategic commodity that has a significant impact on the everyday lives of every American. Gold is not. But, I do see 

the desire to ‘‘hold’’ oil as a hedge against inflation as an interesting new development. I do think the U.S. must think of oil in terms of its national economic security. This means thinking more boldly about conservation and alternative fuels, and 

it means having a more defined use of the SPR. It also means looking more closely 

at how these financial markets for oil are regulated. I believe in unregulated markets and in free and unfettered trade, but oil is special. The oil markets need widely 

set boundaries so that they do not become a hazard to the economy. 

[Responses to the following questions were not received at the 

time the hearing went to press:] 

QUESTIONS FOR JAMES BURKHARD FROM SENATOR BINGAMAN

Question 1. Do you disagree that increased market participation of institutional 

investors and increased volatility of oil prices are correlated? 

Question 2. How long do you see this strong relationship between the dollar and 

the price for oil remaining in tact? And, is it safe to say that this relationship would 

not be as strong without the proliferation of institutional investors in the oil market? 

Question 3. Historically, we’ve become accustomed to thinking of high oil prices 

causing recessions. It seems that this time, we might well be seeing a recession 

that—through a weak dollar and weak financial markets—is causing high oil prices. 

In your opinion, would a more healthy U.S. economy, with a stronger currency and 

a lower risk of inflation, likely result in lower oil prices? 

QUESTIONS FOR JAMES BURKHARD FROM SENATOR DOMENICI

Question 1. Is there any benefit to the market for allowing non-commercial investors (speculators) to participate? 

Question 2. Does the trading of oil derivatives benefit the American consumer and 

the economy? If so, how? 

QUESTIONS FOR JAMES BURKHARD FROM SENATOR TESTER

Question 1. In your testimony, you stated that oil is becoming the new gold. I 

would like to know whether commodities that are essential to our economy and national security should be open to speculators. I understand that they bring liquidity 

to the market and allow for the reallocation of risk, however are there other mechaVerDate Aug 31 2005 11:16 Aug 29, 2008 Jkt 043391 PO 00000 Frm 00100 Fmt 6601 Sfmt 6621 G:\DOCS\43896.TXT SENERGY2 PsN: MONICA
97 

nisms that could be used to effectively manage the oil futures market without placing the price of oil at the whim of speculators and hedge fund managers? 

Question 2. What can be done to protect our economy and our country from an 

over investment in oil? Is there a possibility of over investment or speculation leading to an unsustainable oil bubble? 

Question 3. If speculation is found to be artificially inflating the price of oil, what 

can we do to reduce this? In your opinion, is the CFTC sufficiently capable both of 

regulating all markets on which oil futures are traded to ensure speculation is not 

affecting the price of oil and of acting quickly and effectively when problems arise? 

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