Financial firms that play a dominant role in the energy futures market brought their case against broad limits on speculative trading to federal regulators Wednesday.
Speculative trading has been blamed by some market watchers for widening the oil price swings that have punished industries and consumers.
Marking a potential shift for the government, the Commodity Futures Trading Commission may be moving toward setting new restraints on the amount of trading in energy futures by Wall Street firms and other participants that are solely financial investors.
Blythe Masters, head of JPMorgan Chase's global commodities group, said any new curbs on the size of trading positions that can be held "must be tailored" to address only excessive speculation. "Efforts must be undertaken with the broader understanding that speculation itself plays an essential role in commodities markets," Masters said.
If investors like JPMorgan Chase were discouraged from assuming price risks, she said, oil users that need to hedge risk and rely on financial firms to facilitate that activity "would have much more difficulty entering into transactions" and markets would become more volatile.
JPMorgan Chase and Goldman Sachs are among the biggest players in the energy futures markets.
CFTC Chairman Gary Gensler faulted "excessive" speculation but also underscored the role of financial investors in helping to set fair prices that can benefit consumers.
The agency isn't going to dictate prices, but will use its authority to help ensure "fair and orderly functioning of markets," Gensler said at Wednesday's hearing, the second day of public airing of the issue.
Commissioner Bart Chilton insisted that "going slow is not an option" for the agency in moving to set new limits on speculative energy trading.
Gensler said the CFTC recognizes the positive role played by the Wall Street firms and other speculators in the futures markets, which enable farmers, oil producers and oil users to hedge their risks and facilitates fair determination of prices.
The Wall Street firms have taken "very large positions in unregulated form" in the energy futures market, said Tyson Slocum, director of Public Citizen's energy program.
Only parties that have a direct economic interest in hedging risk, like the airlines and fuel dealers that use the market, should receive exemptions from the regulators from quantity limits on trading, Slocum said at the hearing.
JPMorgan Chase, Goldman Sachs, Citigroup, Bank of America and Morgan Stanley "have turned energy markets into lucrative profit centers for the firms, taking full advantage of the lack of regulatory oversight over their operations to maximize market power and control information," Slocum said.
Gensler cited the CFTC's goal of preventing market power from being concentrated in a small number of powerful financial players.
"I believe we must seriously consider setting strict position limits in the energy markets," he said.
Gensler said last week the agency may propose new rules setting limits in the fall. However, he said the agency has opened the debate to determine how new limits could reduce excessive speculation, "not how we can eliminate speculation."
In a series of hearings, the CFTC is gathering views from consumers, businesses, traders, futures exchanges and financial firms as it weighs possible new restraints.
The futures contracts are supposed to reduce price volatility. But speculators use them to bet on market prices, and critics say this magnifies price swings. Regulators, they maintain, have long let speculation in energy markets inflict financial pain, triggering wild price swings, hurting gasoline wholesalers, damaging airlines and squeezing consumers at the gas pump and airline ticket counter.
By law, the CFTC sets limits on the amount of futures contracts in agricultural products like wheat, corn and soybeans that can be held by each market participant to protect the market against manipulation. But for energy commodities — crude oil, heating oil, natural gas, gasoline and other energy products — it is the futures exchanges themselves that set the position limits.
That divergence has prompted the examination by the CFTC of whether it should step in.
Commissioner Jill Sommers said the agency should carefully approach such intervention in the market. "It's clear to me that the unintended consequences can be significant," she said.
But Chilton warned that speculative activity left unchecked "could have the same dangerous consequences."
Experts and economists are divided on whether speculative trading in the futures markets fans price volatility. Part of the confusion is that "hot" speculative money flows into energy commodities in numerous ways. The CFTC doesn't track all of them, so it's hard to quantify the impact of speculation.
The agency doesn't, for example, keep records of the speculative side bets that traders make. Nor does it monitor markets that include over-the-counter swaps — those that aren't traded on exchanges — by pension funds and other investors.
The Bush administration generally opposed tighter regulation in the financial industry. Among hedge funds and Wall Street banks that invest in and manage billions in commodities trading, the shift to a Democratic White House and a CFTC chairman appointed by President Obama has raised fears of tighter regulation.