Commodity Futures Trading Commission:

Trends in Energy Derivatives Markets Raise Questions about CFTC's Oversight

GAO-08-25: Published: Oct 19, 2007. Publicly Released: Oct 19, 2007.

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Prices for four energy commodities--crude oil, heating oil, unleaded gasoline, and natural gas--have risen substantially since 2002. Some observers believe that higher energy prices are the result of changes in supply and demand. Others believe that increased futures trading activity has also contributed to higher prices. This report, conducted under the Comptroller General of the United States' authority, examines (1) trends and patterns in the physical and energy derivatives markets, (2) the scope of the Commodity Futures Trading Commission's (CFTC) regulatory authority over these markets, and (3) the effectiveness of CFTC's monitoring and detection of market abuses and enforcement. For this work, GAO analyzed futures and large trader data and interviewed market participants, experts, and officials at six federal agencies.

Rising energy prices have been attributed to a variety of factors, among them recent trends (2002-2006) in the physical and futures markets. These trends include (1) factors in the physical markets, such as tight supply, rising demand, and a lack of spare production capacity; (2) higher than average, but declining, volatility (a measure of the degree to which prices fluctuate over time) in energy futures prices for crude oil, heating oil, and unleaded gasoline; and (3) growth in several key areas, including the number of noncommercial participants in the futures markets (including hedge funds), the volume of energy futures contracts traded, and the volume of energy derivatives traded outside of traditional futures exchanges. Because these changes took place concurrently, the effect of any individual trend or factor is unclear. On the basis of its authority under 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. Energy derivatives are also traded on other markets, namely, exempt commercial and over-the-counter (OTC) markets, that are exempt from CFTC oversight. Both types of markets have seen their volumes climb in recent years. Exempt commercial markets are electronic trading facilities where certain commodities, such as energy, are traded between large, sophisticated participants. OTC markets allow eligible parties to enter into contracts directly, without using an exchange. While the exempt commercial and OTC markets are subject to the CEA's antimanipulation and antifraud provisions and CFTC enforcement of those provisions, some market observers question whether CFTC needs broader authority to 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. Moreover, because of changes and innovations in the market, the methods used to categorize these data can distort the information reported to the public, which may not be completely accurate or relevant. 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, this lack of information makes it difficult to determine the usefulness and extent of these activities. In addition, CFTC's performance measures for enforcement 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.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: When Congress passed Dodd-Frank, this matter was addressed. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. The derivatives legislation set forth in Title VII of the Act repeals prior regulatory exemptions for over-the-counter (OTC) derivatives, including energy derivatives, and imposes a regulatory framework upon the OTC derivatives market. In addition, Title VII of the Act provides substantial authority to the Commodity Futures Trading Commission with respect to position limits for certain swaps and may change the standards for determining manipulation.

    Matter: In light of recent developments in derivatives markets and as part of CFTC's reauthorization process, Congress may wish to consider further exploring whether the current regulatory structure for energy derivatives, in particular for those traded in exempt commercial markets, provides adequately for fair trading and accurate pricing of energy commodities.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: Beginning September 2009, CFTC began reporting data on energy and other commodities? trading in its weekly public reports in new categories to capture the trading activities of all participants. For example, CFTC now reports data on the trading positions of newer entrants to the energy market, such as investment banks. As a result, the energy trading information CFTC reports to the public may be more useful, accurate, and relevant, and the energy futures trading market may be more transparent.

    Recommendation: To improve the oversight and available information on energy futures trading, the Acting CFTC Chairman should reexamine the classifications in the Commitment of Traders reports to determine if the commercial and noncommercial trading categories should be refined to improve the accuracy and relevance of public information provided to the energy futures markets.

    Agency Affected: Commodity Futures Trading Commission

  2. Status: Closed - Implemented

    Comments: CFTC has implemented a procedure to prepare a written summary with the expiration of each futures contract of the four major energy markets: natural gas, crude oil, gasoline, and heating oil. In August 2008, the procedure was implemented for natural gas, in January 2009 it was implemented for gasoline and heating oil, and in May 2009 it was implemented for crude oil. The summaries indicate whether there were any market concerns, indications of congestion, price manipulation, or Commodity Exchange Act violations. They are prepared for the expirations each month, reviewed, and action is taken where deemed appropriate.

    Recommendation: To improve the oversight and available information on energy futures trading, the Acting CFTC Chairman should explore ways to routinely maintain written records of inquiries into possible improper trading activity and the results of these inquiries to more fully determine the usefulness and extent of CFTC's surveillance, antifraud, and antimanipulation authorities.

    Agency Affected: Commodity Futures Trading Commission

  3. Status: Closed - Implemented

    Comments: Since the GAO report was issued, CFTC developed a new strategic plan and revised its Enforcement related objectives and performance measures. According to CFTC staff, during its strategic plan development process, CFTC examined ways to demonstrate the effectiveness of all its programs, including Enforcement. The staff noted that the agency continues to strive to develop outcome oriented performance measures, and compliance with applicable laws and regulations is a primary objective. According to CFTC staff, the agency developed and implemented performance measures per its new strategic plan to measure the results of its activities in areas such as investigations and enforcement actions based on leads and referrals and use of domestic and international cooperative enforcement to make and receive referrals and otherwise provide assistance. CFTC staff noted that this response demonstrates that the agency took into consideration the issues raised by GAO's recommendations in crafting its new performance measures.

    Recommendation: To improve the oversight and available information on energy futures trading, the Acting CFTC Chairman should examine ways to more fully demonstrate the effectiveness of CFTC enforcement activities by developing additional outcome-related performance measures that more fully reflect progress in meeting the program's overall goals.

    Agency Affected: Commodity Futures Trading Commission


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