BRICKFIELO BURCHETTE 

RITTS &STONE, PC 

WASHINGTON, o:c. AUSTIN, TEXAS 

July 13, 2009 

Mr. David Stawick, Secretary 

Commodity Futures Trading Commission 

Three Lafay~tte Centre 

1155 21st Street, NW 

Washington, DC 20581 

COMMENT 

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Re: Commodity Futures Trading Commission's ("CFTC" or "Commission") Concept 

Release on Whether to Eliminate the Bona Fide Hedge Exemption for Certain 

Swap Dealers and Create a New Limited Risk Management Exemption from 

Speculative Position Limits ("Concept Release") 

Dear Mr. Stawick: 

Steel Manufacturer's Association ("SMA") and East Texas Electric Cooperative 

("ETEC"), (collectively referred to as "SMA and ETEC") submit this letter in response to 

the CFTC's request for comments that appeared in 74 Fed. Reg.12282. 

The members of SMA and ETEC regularly enter into power purchase agreements 

and hedges, which are largely or directly based on the price of natural gas. ETEC and its 

members regularly execute physical and fmancial natural gas transactions. The members 

of SMA and ETEC are substantially affected by disproportionate financial "investment" 

in natural gas commodities to the extent that such investment creates periods of excessive 

prices and increased volatility. SMA and ETEC take this opportunity to respond to the 

Concept Release Question No. 4: 

4. The existing bona fide hedge exemptions granted by the Commission extend only to 

those agricultural commodities subject to Federal speculative position limits. Should the 

interpretation of bona fide hedging and any new limited risk management exemption 

extend to other physical commodities, such as energy and metals, which are subject to 

exchange position limits or position accountability rules? 

SMA and ETEC strongly support the extension of position limits and 

implementation of the proposed limited risk management exemption to natural gas 

commodities. SMA and ETEC also request that the CFTC reconsider no-action relief 

that exempts commodity index funds from application of position limits. 1 

I· CFTC Letters 06-09 (May 5, 2006) and 06-19 (September 6, 2006). 

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1025 TIIOMAS JEFFERSON STREET, N.W EIGHTII FLOOR, WEST TOWER WASHINGTON, D.C. 20007 (202) 342-0800 FAX (202) 342·0807 www.bbrslaw.com 
Mr. David Stawick, Secretary 

July 13, 2009 

Page2 

BRICKFIELP BURCHETTE 

RITTS ~STONE, PC 

To the extent that exchange traded securities, commodity notes, hedge funds, 

pension funds and similar investment vehicles ("Funds') cause natural gas prices to 

diverge from fundamental valuation and generate excessive volatility, such speculation 

should be limited. SMA and ETEC believe that reasonable position limitations would 

provide for continued liquidity while reducing the influence of these financial 

investments on commodity prices. 

In markets where position limits apply and prevent participants from excessive 

speculation, associated hedge exemptions provide the valuable function of exempting 

swap dealers from these position limits to the extent that they make markets for parties 

that hedge risk? For example, if a fabric manufacturer seeks to hedge the cost of cotton, 

and executes a cotton swap with a dealer, the dealer can apply for a hedge exemption to 

hedge the swap's risk in the futures market, and avoid breaching position limits. 

Otherwise, the particular commodity exchange limits the extent to which the dealer can 

speculate on cotton through application of position limits. The combination of position 

limits and hedge exemptions reasonably limit speculative activities while fostering robust 

commercial hedging programs. 

Unfortunately, the hedge exemption can be applied in a manner that allows for 

certain forms of speculation. Funds that seek large speculative positions can rely on a 

dealer's hedge exemption to effectively launder their speculative positions, 

circumventing position limits. This occurs because an exchange's inquiry into position 

limits primarily relates to the dealer's position and not that of the counterparty seeking 

the hedge. 3 In this manner, Funds that speculate on commodity prices benefit from a tool 

designed to enable commercial hedging, but which was intended to limit speculation.4 

Along with the growth and development of Funds in recent years, commodity prices and 

volatility have similarly risen, sometimes to extraordinary levels. 

Dealer-based hedge exemptions enable Funds to trade without position limits, 

while position limits restrain dealers and any other direct market participant from 

excessive speculation. Funds are limited in speculating only to the extent of their credit 

limit with each dealer. The opaque actions of Funds, shrouded through indirect 

transactions with dealers, inappropriately provide cover from hedge exemptions while 

most others market participants are subject to limits. This disparity supports the notion 

that the hedge exemption is misapplied. 

2 See 17 CFR 38, Appendix B, Core Principle 5. 

3 Rule Enforcement Review of the New York Board of Trade, CFTC, Division of Market Oversight at p. 14 

(October 26, 2005). 

4 See 17 CFR 38, Appendix B, Core Principle 5. 
Mr. David Stawick, Secretary 

July 13, 2009 

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BRICKFIEL:P BURCHETTE 

RITTS e-7" STONE, PC 

If the CFTC implements the proposed limited risk management exemption, this 

would look through the dealer to consider the position of the counterparty to the dealer, 

bringing those parties within the reach of position limits. 

Currently, the CFTC does not directly apply position limits to natural gas 

products. The NYMEX, with regard to its natural gas products, oversees contract 

positions and generally only limits position sizes as contracts approach expiration. SMA 

and ETEC request the CFTC to extend application of position limits to natural gas 

commodity products and implement the proposed limited risk management exemption for 

natural gas commodities. The proposed limited risk management exemption should place 

reasonable limits on the extent to which Funds could trade through dealers to speculate 

on commodities. 

The need for this expansion of CFTC oversight arises due to the sophistication of 

fund managers and the breadth of financial "investment" in natural gas commodity 

products. The CFTC needs the ability to aggregate positions of specific non-commercial 

market participants across all exchanges that make substantial markets in natural gas. 

Without this ability, speculative traders with outsized positions will shift into markets 

where they have yet to reach a position limit, or to a market that has no limit at all. All 

exchanges that maintain a significant market share of the natural gas commodity should 

be subject to these limitations. 

Gaming across exchanges, or the intention to do so, was made patently clear when 

Platts Gas Daily reported the comments of John Hyland, the portfolio manager and chief 

investment officer of United States Natural Gas Fund, LP ("UNG"),5 

on May 22, 2009. 

The natural gas newsletter reported that "Hyland told Platts earlier this week that if 

NYMEX asked the fund to reduce its percentage of open interest, it could move positions 

to ICE."6 For these reasons, ICE Henry Hub natural gas products should also be subject 

to position limits and proposed limited risk management exemption rules. 

Recent trading activity in UNG created concerns for SMA and ETEC regarding 

excessive speculation. The explosion in UNG volume that started in April 2009 and 

peaked in June correlated well with excessive volatility and price increases. The hedging 

5 See UNG Prospectus (May 6, 2009). UNG is a commodity pool and an exchange traded security. The 

investment objective ofUNG is to have the changes in percentage terms of the units' net asset value reflect 

the changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, as 

measured by the changes in the price of the futures contract on natural gas traded on the New York 

Mercantile Exchange that is the near month contract to expire, except when the near month contract is 

within two weeks of expiration, in which case it will be measured by the futures contract that is the next 

month contract to expire, less UNG's expenses. 

6 NYMEX keeping eye on heavily traded gas fund, Platts Gas Daily {Platts), May 22, 2009 p. 7. 
Mr. David Stawick, Secretary 

July 13, 2009 BRICKFIEL:P BURCHETTE 

RITTS C'?"STONE, PC Page4 

associated with these exchange traded security volumes represents a significant portion of 

both ICE and NYMEX open interest.7 Trading activity during this period reversed a 

period of decline in the natural gas markets, despite continued fundamental weakness --

record storage, strong production and substantial excess production capacity. 

We understand that the CFTC is indirectly looking into this issue, in part, under 

its review as described in 74 Fed. Reg. 28028 to determine whether the Henry Financial 

LD1 Fixed Price contract traded on the ICE performs a significant price discovery 

function. SMA and ETEC support that review and a finding that LD 1 is a Significant 

Price Discovery Contract ("SPDC'). Recognition of LD1 as an SPDC would enable 

application of position limits on LD 1 transactions on ICE. SMA and ETEC are also 

filing under that request for comment. 8 

This UNG activity provides a textbook case on the ability of a single commodity 

"investment" product to impact the price of natural gas on the NYMEX and ICE. On 

July 9, 2009, Platts Gas Daily reported rather dramatic comments by traders relating to 

the Security and Exchange Commission's ("SEC") failure to approve the UNG's issuance 

of more shares:9 

The fund, which warned in a Securities and Exchange Commission 

filing Monday that it faced running out of registered units if the SEC did 

not approve its June 5 new-registration request, did just that Tuesday, 

leading the New York Stock Exchange to order a 45-minute trading halt 

for UNG while the fund provided the SEC more information. Several 

traders noted an immediate drop in the August NYMEX gas futures 

contract, which slid 8.2 cents in the last hour of trading. "You saw such a 

bearish reaction immediately," a Houston-based NYMEX trader said. "Big 

black box funds are ready to start arbitraging this." 

Speculation of another large drop Wednesday materialized to some 

degree as the contract closed another 7.6 cents lower ... [Sempra's Brison] 

Bickerton said the halt of new capital into UNG could have a longer-term 

bearish effect on prices. "Getting a 7-cent sell-off despite weather maps 

that are a little bit warmer is impressive. It says that the market is selling 

off in the face of UNG." Stephen Schork, president of Schork Group, 

agreed, saying he believes the lack of new money will have a bearish 

effect on gas prices. "Wall Street has been selling [UNG] since the winter, 

and the clients don't have much to show for it so far. Perhaps this is the 

breather they need to step back and realize just because a commodity is 

8 Notice of Action and Request for Comment, 74 FR 28028 (June 12, 2009). 

9 Traders watch NYMEX for sign of gas fund's impact, Platts Gas Daily (Platts), July 9, 2009 p. 3. 
Mr. David Stawick, Secretary 

July 13, 2009 BRICKFIEL:P BURCHETTE 

RITTS e:?"'STONE, PC PageS 

cheap doesn't mean it has to get expensive," Schork said. "If we take out 

this lift that UNG could have been providing the market, you could very 

well see this flush down below $3." 

A recent report from Credit Suisse said the vacuum created by 

UNG's sudden absence would lead to continued downward pressure on 

prices, and that many UNG investors may take this opportunity to divest 

themselves. "That bid is going to be missing from the futures market now. 

You've filled up a bag and you can't put any more in it. It's a very bearish 

dynamic," a Houston based NYMEX trader added. 

But according to Bickerton, the real impact will come when the 

SEC makes a ruling on whether UNG gets its new units. "It could spark a 

major short-covering market," Bickerton said. "If the market postulates 

that big volumes are on the way, you [might] have a rip-your-face-off 

short-covering rally. It's kind of a scary thought." 

These comments, in summary, indicate that the lack of additional gas purchasing 

by UNG, due to SEC restrictions, generated significant bearish sentiment, and caused 

natural gas prices to fall substantially, presumably toward price levels dictated by market 

fundamentals. If the SEC later determines it would permit the issuance of additional 

UNG shares, there is a risk of a large short covering rally, as the issuance brings UNG 

back to market. 

If the comments of the various market participants in the excerpt above are 

accurate, the UNG exchange traded security created excessive volatility and temporarily 

increased prices above levels suggested by economic fundamentals. Based on the above, 

whether investors in UNG consisted of sophisticated funds, or a herd of individual 

investors, these financial investors significantly impacted natural gas prices. 

In addition to the current lack of CFTC based position limits on exchange traded 

natural gas commodity products, UNG benefits from CFTC no-action letters that indicate 

the CFTC will not subject commodity pools similar to UNG to position limits. 10 Based 

on impact ofUNG, SMA and ETEC also request the CFTC to reconsider this exemption 

from position limits. 

In summary, the CFTC should extend application of position limits, and 

implement the proposed limited risk management exemption for natural gas commodity 

contracts to enable the CFTC to aggregate positions of specific non-commercial market 

participants across all relevant exchanges and prevent excessive speculation from 

creating market dislocations. Due to the apparent excessive impact of UNG on the price 

of natural gas, and for consistency and equity, the CFTC should also reconsider no-action 

10 See CFTC Letters 06-09 (May 5, 2006) and 06-19 (September 6, 2006). 
Mr. David Stawick, Secretary 

July 13, 2009 

Page 6 

. BRICKFIELJ;> BURCHETTE 

RITTS (?'~STONE, PC 

relief granted, which currently exempts commodity index funds and securities from 

position limits. 

Sincerely, 

£}!1~ Peter G. Haller 

Counsel for SMA and ETEC