Commodity Futures Trading Commission: Trends in Energy Derivatives Markets Raise Questions about CFTC's Oversight
Published: 2007-10-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Energy prices for crude oil, heating oil, unleaded gasoline, and natural gas have risen substantially since 2002, generating questions about the role derivatives markets have played and the scope of the Commodity Futures Trading Commission's (CFTC) authority. This testimony focuses on (1) trends and patterns in the futures and physical energy markets and their effects on energy prices, (2) the scope of CFTC's regulatory authority, and (3) the effectiveness of CFTC's monitoring and detection of abuses in energy markets. The testimony is based on the GAO report, Commodity Futures Trading Commission: Trends in Energy Derivatives Markets Raise Questions about CFTC's Oversight ( GAO-08-25 , October 19, 2007). For this work, GAO analyzed futures and large trader data and interviewed market participants, experts, and officials at six federal agencies.
section_title: What GAO Found
paragraphs: Various trends in both the physical and futures markets have affected energy prices. Specifically, tight supply and rising demand in the physical markets contributed to higher prices as global demand for oil has risen rapidly while spare production capacity has fallen since 2002. Moreover, increased political instability in some of the major oil-producing countries has threatened the supply of oil. During this period, increasing numbers of noncommercial participants became active in the futures markets (including hedge funds) and the volume of energy futures contracts traded also increased. Simultaneously, the volume of energy derivatives traded outside of traditional futures exchanges increased significantly. Because these developments took place concurrently, the effect of any individual trend or factor on energy prices is unclear. Under the authority granted by the Commodity Exchange Act (CEA), CFTC focuses its oversight primarily on the operations of traditional futures exchanges, such as the New York Mercantile Exchange, Inc. (NYMEX), where energy futures are traded. Increasing amounts of energy derivatives trading also occur on markets that are largely exempt from CFTC oversight. For example, exempt commercial markets conduct trading on electronic facilities between large, sophisticated participants. In addition, considerable trading occurs in over-the-counter (OTC) markets in which eligible parties enter into contracts directly, without using an exchange. While CFTC can act to enforce the CEA's antimanipulation and antifraud provisions for activities that occur in exempt commercial and OTC markets, some market observers question whether CFTC needs broader authority to more routinely oversee these markets. CFTC is currently examining the effects of trading in the regulated and exempt energy markets on price discovery and the scope of its authority over these markets--an issue that will warrant further examination as part of the CFTC reauthorization process. CFTC conducts daily surveillance of trading on NYMEX that is designed to detect and deter fraudulent or abusive trading practices involving energy futures contracts. To detect abusive practices, such as potential manipulation, CFTC uses various information sources and relies heavily on trading activity data for large market participants. Using this information, CFTC staff may pursue alleged abuse or manipulation. However, because the agency does not maintain complete records of all such allegations, determining the usefulness and extent of these activities is difficult. In addition, CFTC's performance measures for its enforcement program do not fully reflect the program's goals and purposes, which could be addressed by developing additional outcome-based performance measures that more fully reflect progress in meeting the program's overall goals. Because of changes and innovations in the market, the reports that CFTC receives on market activities may no longer be accurate because they use categories that do not adequately separate trading being done for different reasons by various market participants.

section_title: Letter
paragraphs: I am pleased to be here today to discuss our recent report on the trading of  derivatives for energy commodities, including crude oil and natural gas,  and the Commodity Futures Trading Commission’s (CFTC) oversight of  these markets. The expansion of derivatives trading in energy markets,  particularly by participants such as hedge funds, and rapid growth in  trading off regulated exchanges have raised questions about the quality  and quantity of reporting on and oversight of these trading activities.
Specifically, I will discuss (1) trends in the physical and energy derivatives  markets and their effect on energy prices, (2) the scope of CFTC’s  authority for protecting market users in the trading of energy derivatives,  and (3) CFTC’s monitoring and detection of market abuses in energy  futures markets. I should point out that our review was intended to  identify trends in both the physical and derivatives energy markets and to  provide information on the current regulatory structure for energy  derivatives trading, including analyzing the various perspectives of market  participants on these issues. While our report frames issues that need to  be addressed, we do not offer specific policy solutions.
During the course of our review, we obtained and analyzed energy futures  prices and trading volumes from the New York Mercantile Exchange, Inc.  (NYMEX). Specifically, we collected data for crude oil, heating oil, natural  gas, and unleaded gas from January 2002 through December 2006. We also  analyzed data obtained from CFTC on market participants and the  outstanding trading positions of different categories of traders. We  reviewed publicly available information, including academic studies and  reports and market data. Finally, we interviewed a broad range of market  participants and observers, representatives of energy trading markets, and  government regulators and agencies involved with the energy markets.  This work was done in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: Energy commodities are bought and sold on both the physical and  financial markets. The physical market includes the spot market where  products such as crude oil or gasoline are bought and sold for immediate  or near-term delivery by producers, wholesalers, and retailers. Spot  transactions take place between commercial participants for a particular  energy product for immediate delivery at a specific location. For example,  the U.S. spot market for West Texas Intermediate crude oil is the pipeline  hub near Cushing, Oklahoma, while a major spot market for natural gas  operates at the Henry Hub near Erath, Louisiana. The prices set in the  specific spot markets provide a reference point that buyers and sellers use  to set the price for other types of the commodity traded at other locations.
In addition to the spot markets, derivatives based on energy commodities  are traded in financial markets. The value of the derivative contract  depends on the performance of the underlying asset—for example, crude  oil or natural gas. Derivatives include futures, options, and swaps. Energy  futures include standardized exchange-traded contracts for future delivery  of a specific crude oil, heating oil, natural gas, or gasoline product at a  particular spot market location. An exchange designated by CFTC as a  contract market standardizes the contracts. The owner of an energy  futures contract is obligated to buy or sell the commodity at a specified  price and future date. However, the contractual obligation may be  removed at any time before the contract expiration date if the owner sells  or purchases other contracts with terms that offset the original contract.  In practice, most futures contracts on NYMEX are liquidated via offset, so  that physical delivery of the underlying commodity is relatively rare.
Market participants use futures markets to offset the risk caused by  changes in prices, to discover commodity prices, and to speculate on price  changes. Some buyers and sellers of energy commodities in the physical  markets trade in futures contracts to offset or “hedge” the risks they face  from price changes in the physical market. Exempt commercial markets  and OTC derivatives are also used to hedge this risk. The ability to reduce  their price risk is an important concern for buyers and sellers of energy  commodities, because wide fluctuations in cash market prices introduce  uncertainty for producers, distributors, and consumers of commodities  and make investment planning, budgeting, and forecasting more difficult.  To manage price risk, market participants may shift it to others more  willing to assume the risk or to those having different risk situations. For  example, if a petroleum refiner wants to lower its risk of losing money  because of price volatility, it could lock in a price by selling futures  contracts to deliver the gasoline in 6 months at a guaranteed price.  Without futures contracts to manage risk, producers, refiners, and others  would likely face greater uncertainty.
By establishing prices for future delivery, the futures market also helps  buyers and sellers determine or “discover” the price of commodities in the  physical markets, thus linking the two markets together. Markets are best  able to perform price discovery when (1) participants have current  information about the fundamental market forces of supply and demand,  (2) large numbers of participants are active in the market, and (3) the  market is transparent. Market participants monitor and analyze a myriad  of information on the factors that currently affect and that they expect to  affect the supply of and demand for energy commodities. With that  information, participants buy or sell an energy commodity contract at the  price they believe the commodity will sell for on the delivery date. The  futures market, in effect, distills the diverse views of market participants  into a single price. In turn, buyers and sellers of physical commodities may  consider those predictions about future prices, among other factors, when  setting prices on the spot and retail markets.
Other participants, such as investment banks and hedge funds, which do  not have a commercial interest in the underlying commodities, generally  use the futures market for profit. These speculators provide liquidity to the  market but also take on risks that other participants, such as hedgers, seek  to avoid. In addition, arbitrageurs attempt to make a profit by  simultaneously entering into several transactions in multiple markets in an  effort to benefit from price discrepancies across these markets.
section_title: Several Factors Have Caused Changes in the Energy Markets, Potentially Affecting Energy Prices
paragraphs: The physical markets for energy commodities underwent change and  turmoil from 2002 through 2006, which affected prices in the spot and  futures markets. We reported that numerous changes in both the physical  and futures markets may have affected energy prices. However, because  these changes occurred simultaneously, identifying the specific effect of  any one of these changes on energy prices is difficult.
subsections: section_title: Various Changes in the Physical Market Contributed to Rising Prices
paragraphs: The physical energy markets have undergone substantial change and  turmoil during this period, which can affect spot and futures markets. Like  many others, we found that a number of fundamental supply and demand  conditions can affect prices. According to the Energy Information  Administration (EIA), world oil demand has grown since 1983 from a low  of about 59 million barrels per day in 1983 to more than 85 million barrels  per day in 2006 (fig. 1). While the United States accounts for about a  quarter of this demand, rapid economic growth in Asia also has stimulated  a strong demand for energy commodities. For example, EIA data show  that during this time frame, China’s average daily demand for crude oil  increased almost fourfold.
The growth in demand does not, by itself, lead to higher prices for crude  oil or any other energy commodity. For example, if the growth in demand  were exceeded by a growth in supply, prices would fall, other things  remaining constant. However, according to EIA, the growth in demand  outpaced the growth in supply, even with spare production capacity  included in supply. Spare production capacity is surplus oil that can be  produced and brought to the market relatively quickly to rebalance the  market if there is a supply disruption anywhere in the world oil market. As  shown in figure 2, EIA estimates that global spare production capacity in  2006 was about 1.3 million barrels per day, compared with spare capability  of about 10 million barrels per day in the mid-1980s and about 5.6 million  barrels a day as recently as 2002.
Major weather and political events also can lead to supply disruptions and  higher prices. In its analysis, EIA has cited the following examples:    Hurricanes Katrina and Rita removed about 450,000 barrels per day from  the world oil market from June 2005 to June 2006.
Instability in major oil-producing countries of the Organization of  Petroleum Exporting Countries (OPEC), such as Iran, Iraq, and Nigeria,  have lowered production in some cases and increased the risk of future  production shortfalls in others.
Oil production in Russia, a major driver of non-OPEC supply growth  during the early 2000s, was adversely affected by a worsened investment  climate as the government raised export and extraction taxes.
The supply of crude oil affects the supply of gasoline and heating oil, and  just as production capacity affects the supply of crude oil, refining  capacity affects the supply of those products distilled from crude oil. As  we have reported, refining capacity in the United States has not expanded  at the same pace as the demand for gasoline. Inventory, another factor  affecting supplies and therefore prices, is particularly crucial to the supply  and demand balance, because it can provide a cushion against price spikes  if, for example, production is temporarily disrupted by a refinery outage or  other event. Trends toward lower levels of inventory may reduce the costs  of producing gasoline, but such trends also may cause prices to be more  volatile. That is, when a supply disruption occurs or there is an increase in  demand, there are fewer stocks of readily available gasoline to draw on,  putting upward pressure on prices.
Another consideration is that the value of the U.S. dollar on open currency  markets could affect crude oil prices. For example, because crude oil is  typically denominated in U.S. dollars, the payments that oil-producing  countries receive for their oil also are denominated in U.S. dollars. As a  result, a weak U.S. dollar decreases the value of the oil sold at a given  price, and oil-producing countries may wish to increase prices for their  crude oil in order to maintain the purchasing power in the face of a  weakening U.S. dollar to the extent they can.
section_title: The Effect on Prices of Relatively High but Falling Volatility and a Growing Volume of Trading in Derivatives Is Unclear
paragraphs: As you can see, conditions in the physical markets have undergone  changes that can help explain at least some of the increases in both  physical and derivatives commodity prices. As we have previously  reported, futures prices typically reflect the effects of world events on the  price of the underlying commodity such as crude oil. For example,  political instability and terrorist acts in countries that supply oil create  uncertainties about future supplies, which are reflected in futures prices.  Conversely, news about a new oil discovery that would increase world oil  supply could result in lower futures prices. In other words, changes in the  physical markets influence futures prices.
At the same time that physical markets were undergoing changes, we  found that financial markets also were amidst change and evolution. For  example, the annual historical volatilities between 2000 and 2006— measured using the relative change in daily prices of energy futures— generally were above or near their long-term averages, although crude oil  and heating oil declined below the average and gasoline declined slightly  at the end of that period. We also found that the annual volatility of natural  gas fluctuated more widely than that of the other three commodities and  increased in 2006 even though prices largely declined from the levels  reached in 2005. Although higher volatility is often equated with higher  prices, this pattern illustrates that an increase in volatility does not  necessarily mean that price levels will increase. In other words, price  volatility measures the variability of prices rather than the direction of the  price changes.
Elsewhere in the futures market, we found an increase in the number of  noncommercial traders such as managed money traders. Attracted in part  by the trends in prices and volatility, a growing number of traders sought  opportunities to hedge against those changes or profit from them. Using  CFTC’s large trader data, we found that from July 2003 to December 2006,  crude oil futures and options contracts experienced the most dramatic  increase, with the average number of noncommercial traders more than  doubling from about 125 to about 286. As shown in figure 3, while the  growth was less dramatic in the other commodities, the average number of  noncommercial traders also showed an upward trend for unleaded  gasoline, heating oil, and natural gas.
Not surprisingly, our work also revealed that as the number of traders  increased, so did the trading volume on NYMEX for all energy futures  contracts, particularly crude oil and natural gas. Average daily contract  volume for crude oil increased by 90 percent from 2001 through 2006, and  natural gas increased by just over 90 percent. Unleaded gasoline and  heating oil experienced less dramatic growth in their trading volumes over  this period.
While much harder to quantify, another notable trend was the significant  increase in the amount of energy derivatives traded outside exchanges.  Trading in these markets is much less transparent, and comprehensive  data are not available because these energy markets are not regulated.  However, using the Bank for International Settlements data as a rough  proxy for trends in the trading volume of OTC energy derivatives, the face  value or notional amounts outstanding of OTC commodity derivatives  excluding precious metals, such as gold, grew from December 2001 to  December 2005 by more than 850 percent to over $3.2 trillion.
Further, while some market observers believe that managed money  traders were exerting upward pressure on prices by predominantly buying  futures contracts, CFTC data we analyzed revealed that from the middle of  2003 through the end of 2006, the trading activity of managed money  participants became increasingly balanced between buying (those that  expect prices to go up) and selling (those that expect prices to go down).  Using CFTC large trader reporting data, we found that from July 2003  through December 2006, managed money traders’ ratio of buying (long) to  selling (short) open interest positions was 2.5:1 indicating that on the  whole, this category of participants was 2.5 times as likely to expect prices  to rise as opposed to fall throughout that period, which they did. However,  as figure 4 illustrates, by 2006, this ratio fell to 1.2:1, suggesting that  managed money traders as a whole were more evenly divided in their  expectations about future prices. As you can see, managed money trading  in unleaded gasoline, heating oil, and natural gas showed similar trends.
Overall, we found that views were mixed about whether these trends put  any upward pressure on prices. Some market participants and observers  have concluded that large purchases of oil futures contracts by  speculators could have created an additional demand for oil that could  lead to higher prices. Conversely, some federal agencies and other market  observers took the position that speculative trading activity did not have a  significant impact on prices. For example, an April 2005 CFTC study of the  markets concluded that increased trading by speculative traders, including  hedge funds, did not lead to higher energy prices or volatility. This study  also argued that hedge funds provided increased liquidity to the market  and dampened volatility. Still others told us that while speculative trading  in the futures market could contribute to short-term price movements in  the physical markets, they did not believe it was possible to sustain a  speculative “bubble” over time, because the two markets were linked and  both responded to information about changes in supply and demand  caused by such factors as the weather or geographical events. In the view  of these observers and market participants, speculation could not lead to  artificially high or low prices over a long period.
section_title: CFTC Oversees Exchanges and Has Limited Authority over Other Derivatives Markets
paragraphs: Under CEA, CFTC’s authority for protecting market users from fraudulent,  manipulative, and abusive practices in energy derivatives trading is  primarily focused on the operations of traditional futures exchanges, such  as NYMEX, where energy futures are traded. Off exchange markets, which  are available only to eligible traders of certain commodities under  specified conditions, are not regulated, although CFTC may enforce  antimanipulation and antfraud provisions of the CEA with respect to  trading in those markets. The growth in trading off exchange has raised  questions about the sufficiency of CFTC’s limited authority over these  markets. These changes and innovations also have brought into question  the methods CFTC uses to categorize published data about futures trading  by participants in the off exchange markets and whether information  about their activities in off exchange markets would be useful to the  public. CFTC is taking steps to better understand these issues. Most  importantly, it is currently examining the relationship between trading in  the regulated and exempt energy markets and the role this trading plays in  the price discovery process. It is also examining the sufficiency of the  scope of its authority over these markets—an issue that will warrant  further examination as part of the CFTC reauthorization process.
subsections: section_title: CFTC Has General Oversight Authority over Futures Exchanges, but Information on These Exchanges Reported to the Public Has Not Kept Pace With Changing Market Conditions
paragraphs: To help provide transparency in the markets, CFTC provides the public  information on open interest in exchange-traded futures and options by  commercial and noncommercial traders for various commodities in its  weekly Commitment of Traders (COT) reports. As we reported, CFTC  observed that the exchange-traded derivatives markets, as well as trading  patterns and practices, have evolved. In 2006, CFTC initiated a  comprehensive review of the COT reporting program out of concern that  the reports in their present form might not accurately reflect the  commercial or noncommercial nature of positions held by nontraditional  hedgers, such as swaps dealers. A disconnect between the classifications  and evolving trading activity could distort the accuracy and relevance of  reported information to users and the public, thereby limiting its  usefulness for both.
In December 2006, CFTC announced a 2-year pilot program for publishing  a supplemental COT report that includes positions of commodity index  traders in a separate category. However, the pilot does not include any  energy commodities. Although commodity index traders are active in  energy markets, according to CFTC officials, currently available data  would not permit an accurate breakout of index trading in these markets.  For example, some traders, such as commodity index pools, use the  futures markets to hedge commodity index positions they hold in the OTC  market. However, these traders also may have positions in the physical  markets, which means the reports that CTFC receives on market activities,  which do not include such off-exchange transactions, may not present an  accurate picture of all positions in the market place for the commodity. In  response to our recommendation to reexamine the COT classifications for  energy markets, CFTC agreed to explore whether the classifications  should be refined to improve their accuracy and relevance.
section_title: CFTC Authority over Exempt Commercial Markets and OTC Markets Is Limited, and Views Vary about the Sufficiency of Its Regulatory Authority with Respect to Off-Exchange Energy Derivatives
paragraphs: Now let me address some of the larger policy issues associated with  CFTC’s oversight of these markets. Under CEA, CFTC’s authority for  protecting market users from fraudulent, manipulative, and abusive  practices in energy derivatives trading is primarily focused on the  operations of traditional futures exchanges, such as NYMEX, where  energy futures are traded. Currently, CFTC receives limited information on  derivatives trading on exempt commercial markets—for example, records  of allegations or complaints of suspected fraud or manipulation, and price,  quantity, and other data on contracts that average five or more trades a  day. The agency may receive limited information, such as trading records,  from OTC participants to help CFTC enforce the CEA’s antifraud or  antimanipulation provisions. The scope of CFTC’s oversight authority has  raised concerns among some members of Congress and others that  activities on these markets are largely unregulated, and that additional  CFTC oversight is needed.
While some observers have called for more oversight of OTC derivatives,  most notably for CFTC to be given greater oversight authority of this  market, others oppose any such action. Supporters of more CFTC  oversight authority believe that regulation of OTC derivatives markets is  necessary to protect the regulated markets and consumers from potential  abuse and possible manipulation. One of their concerns is that, due to the  lack of complete information on the size of this market or the terms of the  contracts, CFTC may not be assured that trading on the OTC market is not  adversely affecting the regulated markets and, ultimately, consumers.  However others, including the President’s Working Group, have concluded  that OTC derivatives generally are not subject to manipulation because  contracts are settled in cash on the basis of a rate or price determined in a  separate, highly liquid market that does not serve a significant price  discovery function. The Working Group also noted that if electronic  markets were to develop and serve a price discovery function, then  consideration should be given to enacting a limited regulatory regime  aimed at enhancing market transparency and efficiency through CFTC, as  the regulator of exchange-traded derivatives.
However, the lack of reported data about this market makes addressing  concerns about its function and effect on regulated markets and entities  challenging. In a June 2007 Federal Register release clarifying its large  trader reporting authority, CFTC noted that having data about the off- exchange positions of traders with large positions on regulated futures  exchanges could enhance the commission’s ability to deter and prevent  price manipulation or other disruptions to the integrity of the regulated  futures markets. According to CFTC officials, the commission has  proposed amendments to clarify its authority under the CEA to collect  information and bring fraud actions in principal-to-principal transactions  in these markets, enhancing CFTC’s ability to enforce antifraud provisions  of the CEA.
Also, in September 2007, CFTC conducted a hearing to begin examining  trading on regulated exchanges and exempt commercial markets more  closely. The hearing focused on a number of issues, including  the current tiered regulatory approach established by the Commodity  Futures Modernization Act, which amended the CEA, and whether this  model is beneficial; the similarities and differences between exempt commercial markets and  regulated exchanges, and the associated regulatory risks of each market;  and the types of regulatory or legislative changes that might be appropriate to  address any identified risks.
Given ongoing questions about the similarity of products traded on the  markets and how and whether exempt markets play a role in the price  discovery process and whether existing reporting requirements are  sufficient, we recommend that Congress take up this issue during the  CFTC reauthorization process to begin to answer some of these questions  and the implications for the current regulatory structure in light of the  changes that have occurred in this market.
section_title: CFTC Engages in Large Trader Reporting, Surveillance, and Enforcement Activities, but the Effectiveness of the Activities Is Largely Uncertain
paragraphs: CFTC provides oversight for commodity futures markets by analyzing  large trader reporting data, conducting routine surveillance, and  investigating and taking enforcement actions against market participants  and others. The commission uses information gathered from surveillance  activities to identify unusual trading activity and possible market abuse. In  particular, CFTC’s large trader reporting system (LTRS) provides essential  information on the majority of all trading activity on futures exchanges.  CFTC staff said they routinely investigate traders with large open  positions, but do not routinely maintain information about such inquiries,  thereby making it difficult to determine the usefulness and extent of these  activities. According to recent data provided by CFTC, about 10 percent of  the enforcement actions involved energy-related commodities. However,  as with programs operating in regulatory environments where  performance is not easily measurable, evaluating the effectiveness of  CFTC’s enforcement activities is challenging because it lacks effective  outcome-based performance measures.
subsections: section_title: CFTC Oversight Includes Surveillance of Energy Futures Trading, but the Full Extent of Follow-up Activities Is Uncertain
paragraphs: CFTC conducts regular market surveillance and oversight of energy  trading on NYMEX and other futures exchanges, focusing on detecting and  preventing disruptive practices before they occur and keeping the CFTC  commissioners informed of possible manipulation or abuse. According to  CFTC staff, when a potential market problem has been identified,  surveillance staff generally contact the exchange or traders for more  information. To confirm positions and determine intent, staff may question  exchange employees, brokers, or traders. According to the staff, CFTC’s  Division of Market Oversight may issue a warning letter or make a referral  to the Division of Enforcement to conduct a nonpublic investigation into  the trading activity. Markets where surveillance problems have not been  resolved may be included in reports presented to the commission at  weekly surveillance meetings.
According to CFTC staff, they routinely make inquiries about traders with  large open positions approaching expiration, but formal records of their  findings are only kept in cases with evidence of improper trading. If LTRS  data revealed that a trader had a large open market position that could  disrupt markets if it were not closed before expiration, CFTC staff would  contact the trader to determine why the trader had the position and what  plans the trader had to close the position before expiration or ensure that  the trader was able to take delivery. If the trader provided a reasonable  explanation for the position and a reasonable delivery or liquidation  strategy, staff said no further action would be required. CFTC staff said  they would document such contacts on the basis of their importance in  either informal notes, e-mails to supervisors, or informal memorandums.  According to one CFTC official, no formal record would be made unless  some signal indicated improper trading activity. However, without such  data, CFTC’s measures of the effectiveness of its actions to combat fraud  and manipulation in the markets would not reflect all surveillance activity,  and CFTC management might miss opportunities to identify trends in  activities or markets and better target its limited resources. In response to  our recommendation, CFTC agreed to improve its documentation of its  surveillance activities.
section_title: CFTC Energy-Related Enforcement Actions Generally Involved Allegations of False Reporting and Attempted Manipulation, but Its Program Received a Mixed Rating and Lacks Effective Outcome-Based Performance Measures
paragraphs: CFTC’s Division of Enforcement is charged with enforcing the  antimanipulation sections of the CEA. The enforcement actions CFTC  has taken in its energy-related cases generally have involved false public  reporting as a method of attempting to manipulate prices on both the  NYMEX futures market and the off-exchange markets. CFTC officials said  that from October 2000 to September 2005, the agency initiated 287  enforcement cases and more than 30 of these cases involved energy  trading. In the past several months, CFTC has taken a series of actions  involving energy commodities, including allegations of false reporting,  attempted manipulation of NYMEX natural gas futures prices, and  attempted manipulation of physical natural gas prices.
Although CFTC has undertaken enforcement actions and levied fines,  measuring the effectiveness of these activities is an ongoing challenge. For  example, the Office of Management and Budget’s most recent 2004  Program Assessment Rating Tool (PART) assessment of the CFTC  enforcement program identified a number of limitations of CFTC’s  performance measures. As is the case with most enforcement programs,  identifying outcome-oriented performance measures can be particularly  challenging. However, as we point out in the report, there are a number  of other ways to evaluate program effectiveness, such as using expert  panel reviews, customer service surveys, and process and outcome  evaluations. We have found with other programs that the form of the  evaluations reflects differences in program structure and anticipated  outcomes, and that the evaluations are designed around the programs and  what they aim to achieve. Without utilizing these or other methods to  evaluate program effectiveness, CFTC is unable to demonstrate whether  its enforcement program is meeting its overall objectives. CFTC has  agreed that this is a matter that should be examined and has included  development of measures to evaluate its effectiveness in its strategic plan  and has requested funding to study the feasibility of developing more  meaningful measures.
In closing, I would like to reemphasize the difficulty in attributing  increased energy prices to any one of the numerous changes in the  physical or derivatives markets. As I have mentioned, our research shows  that the physical and derivatives markets have both undergone substantial  change and evolution, and market participant and regulatory views were  mixed about the extent to which these developments exerted upward  pressure on prices. Because of the importance of understanding the  potential effects of such developments in these markets, ongoing review  and analysis are warranted. As the scope of CFTC’s authority is debated,  additional information is needed to understand what may need to be done  to best protect investors from fraudulent, manipulative, and abusive  practices. Such information includes    how different or similar are the characteristics and uses of exchange and  off-exchange products being traded and do these continue to justify  different regulatory treatment; to what extent does trading in off-exchange financial derivatives affect  price discovery and what are the regulatory and policy implications;   how large of an effect are nontraditional market participants, such as  commodity index funds, having in these markets; and   are the changes in the energy markets unique or are such concerns also  worth reviewing for other commodity markets.
By answering questions such as these, CFTC and the Congress will be  better positioned to determine what changes, if any, may be needed to  oversee these markets.
Mr. Chairman, this concludes my prepared statement. I would be happy to  respond to any questions that you or other members of the subcommittee  might have.
section_title: GAO Contacts
paragraphs: For further information about this testimony, please contact Orice M.  Williams on (202) 512-8678 or at williamso@gao.gov.
section_title: Staff Acknowledgments
paragraphs: Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this statement. Individuals making  key contributions include Cody Goebel (Assistant Director), John  Forrester, Barbara Roesmann, and Paul Thompson.
This is a work of the U.S. government and is not subject to copyright protection in the  United States.  The published product may be reproduced and distributed in its entirety  without further permission from GAO. However, because this work may contain  copyrighted images or other material, permission from the copyright holder may be  necessary if you wish to reproduce this material separately.