Comfort Line - Questions and Answers

This quarter our question and answer segment examines the rapid increase and subsequent decline in energy prices.

Why did energy prices increase so rapidly over a short period of time?

This question has been asked by many Americans. There is probably no one right answer. Economic fundamentals such as lack of refinery capacity and oil reserves in the United States, failure to conserve and develop alternate fuels and the rapid growth of China’s and India’s economies are contributing factors. World political events such as the war in Iraq and international difficulties in major oil producing countries like Iran and Venezuela have clearly affected prices. In addition, several experts believe that market manipulation in the energy futures markets have had a significant effect on prices.

What do you mean by market manipulation?

Energy futures contracts are traded on a daily basis on the New York Mercantile Exchange (NYMEX) and on the Over The Counter Exchange (OTC), also known as the Intercontinental Exchange. The contracts that are traded include crude oil, gasoline, heating oil, propane and natural gas. The Industrial Energy Consumers of America has estimated that more than 90% of the trading volume on these exchanges is conducted by individuals or entities that have no relationship to the energy industries. In other words, a large percentage of the volume consists of trading by hedge funds, speculators and other organizations that make their living by investing in the markets.

Are these exchanges regulated by the government?

The Commodity Futures Trading Commission (CFTC) is a government agency that was set up to oversee trading on commodity futures exchanges. The CFTC regulates trading activity on the NYMEX. However, OTC trading is exempt from regulation by the CFTC. Michael Dunn, the commissioner of the CFTC, recently said, "However, a large portion of energy trading occurs in the over-the-counter market, mostly beyond the scrutiny of any federal agency...Because the CFTC is barred from regulating the OTC energy markets, it cannot collect large trader data from unregulated energy markets or conduct regular surveillance of them. It is virtually impossible to know, therefore, the extent of fraud and manipulation that may be occurring in the over-the-counter markets."

Why doesn’t the CFTC have regulatory authority over the OTC market?

That is an interesting question that many people are beginning to ask. Congress is now focusing on this issue. Senators Norm Coleman and Carl Levin, who are members of the Permanent Subcommittee on Investigations, issued a report that stated, "While it is not possible to determine the precise dollar increase in the price of oil attributable to market speculation, some analysts have estimated that speculation has added as much as $20- $25 to the price of each barrel of oil, thereby pushing up oil from about $50 to around $70 per barrel."

Why have energy prices fallen as quickly as they rose?

This is another question that is not easy to answer. Clearly, the economic and geopolitical factors which are said to have caused prices to increase still exist. Although a large new oil field was recently discovered in the Gulf of Mexico, that field will not be producing oil for many years. It is arguable that, at least in part, the decline can be explained by the fact that hedge funds and other speculators have begun to leave the energy futures markets.