Quelle Surprise! Commodities Regulators Lack Adequate Information About Their Markets

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One of the polarized and emotionally charged debates these days (Cassandra compared it to Israel vs. Palestine) is whether the runup in oil prices is due to speculation or fundamental forces. And these extreme views tend to drown out notions that complex phenomena or conflating factors might be at work.

One way to get to the bottom of this would be to look at data. But as we’ve noted, the information on oil is dubious at best. Consider this 2005 interview of peak oil proponent Matt Simmons (hat tim Jim Bianco):

One of the more intriguing stories in “Twilight in the Desert’, Simmons’ new book on the state of Saudi fields, is paucity of reliable data on Middle East production in general and Saudi production, specifically. Simmons is one of the first people to point out the fact that much of the data underlying “official” production numbers are unreliable, based largely on the findings of Petrologistics, a “powerful” information collecting company located over a supermarket in Geneva, Switzerland.

According to Simmons, this company is usually the first one the media “glums” onto each month when the latest Middle East production numbers are released. This data, he alleges is gathered from a worldwide network of harbor “spies” located in the world’s top oil export countries.

“They look through a pair of binoculars and a sort of a gauge in their windows to check [tanker] plumb lines as to how much oil is being loaded into the tankers. And [Conrad Gerber’s] story is he can’t disclose the names of his harbor spies; he can’t even call them at home because when he used to do that, one of them got killed.

What’s interesting is that there are twenty other people… sources that report Middle East oil, but they all seem to get their first data from Petrologistics. And again, no one has ever basically questioned, Well how does he get that data?” Simmons explained. He pointed out the obvious problem that even with harbor spies using binoculars and plumb lines, there is no way to know the grade of the oil and how much being pumped aboard the vessel or its ultimate destination.

“You have no idea if its 1.8 million barrels or 2.2 million barrels. You have no idea where the tankers going,” he said. “But again, no one ever thought about where this data comes from.

“We have an energy data system created today that is simply rubbish.”

Now there are good reasons for it to be difficult to get reliable information on oil supplies and demand. It would take a considerable, coordinated effort to capture the data, and quite a few parties find in not in their interest to participate.

But financial instruments are a completely different matter. There should be comprehensive information about contracts traded on exchanges, and a diligent regulator could also require extensive reporting on OTC activity.

Ah, but we live in the regulation hatin’ US of A. Inconvenience a financial firm by making it prepare some reports on off-exchange activity? That thought would never cross a supervisor’s mind (and in fairness, even if some enterprising regulator had had that bright idea, the industry probably would have cut off his air supply by getting Congress to trim his budget. That threat was used regularly against Arthur Levitt, the chairman of the SEC in the Clinton era).

But the Wall Street Journal not only tells us that the CFTC is clueless about OTC commodities trading (that was to be expected) which happens also to be the preferred route of large index investors, it also says the CFTC’s information about activities on regulated exchanges isn’t up to snuff either. The CFTC takes the limited date on so-called swaps trades and designates them as commercial for external reporting purposes. However, it is widely believed that the majority of these swaps trades are made by financial players (note we and others have mentioned this before, but the point bears repeating).

To give an idea how contentious this issue has become: one CFTC commissioner, Bart Chilton, disputes the notion that the agency can determine whether speculation is playing a role in rising commodities prices.

From the Wall Street Journal:

Plaguing both sides of this debate is a shortage of data about a thriving sector of the market: the customized market for derivatives known as swaps. Wall Street banks such as Morgan Stanley and Goldman Sachs have developed swaps to allow pension funds, hedge-fund traders and commodity companies to bet on prices among themselves, largely outside the regulatory surveillance of the CFTC.

Investors can make larger trades through swaps dealers than they could make directly on a futures exchange. Until this month, the CFTC has not required Wall Street swaps dealers to routinely provide more detail on who these customers are.

“We’re trying to get our arms around the market…before we make hard-and-fast conclusions,” Mr. Lukken told a Senate committee June 24.

The CFTC defends its data as the best global futures markets have to offer. Gregory Mocek, CFTC enforcement chief, said in a recent speech that the agency can identify, with the press of a button, who had the most profitable trades in a particular market going back three days, three months or three years.

Still, Mr. Mocek did not advocate expanding surveillance to swaps. “It is my personal opinion that, given the size of that segment of the marketplace, the cost would be far too great.”

The CFTC and Congress long ago gave blessings to the development of this market. In 1993, then-Chairwoman Wendy Gramm sided with energy companies and pushed through a rule change to exempt from CFTC regulation customized energy derivatives that did not trade on registered exchanges. In 2000, Congress firmed up this “swaps exemption” with passage of the Commodity Futures Modernization Act.

Swaps have grown so popular that they are the primary means by which institutional investors have made massive bullish bets since 2002, totaling an estimated $260 billion in indexes linked to the price of a basket of commodities. At a hearing in early June, the CFTC said 85% of index investing is done outside of regulated futures exchanges.

The Bank for International Settlements, a global body that surveys central banks, puts the notional value of all over-the-counter commodity instruments at $9 trillion.

Because an estimated 50% or more of this market consists of instruments related to crude oil, a report from research company ISI Group says over-the-counter oil trading could be as much as 18½ times larger than the total oil bets outstanding on the main regulated energy-futures market, the New York Mercantile Exchange.

CFTC commissioner Bart Chilton says the lack of deeper data on this key market calls into question the CFTC’s previous conclusions about speculators. “We didn’t have the data that we needed to make the statements that we made,” Mr. Chilton says. “And the data we did have didn’t support our declarative statements. If we were so right, why the heck are we doing a study now?”

As oil kept rising this year, the agency’s chief economist, Jeffrey Harris, continued to argue that speculators did not appear to be pushing up prices. He emphasized in May 20 testimony to Congress that the CFTC has seen as much growth in commercial traders such as oil companies, utilities and airlines as it has in “noncommercial” traders, or those it typically considered speculators.

Mr. Harris said his office has “studied the impact of speculators as a group” and found that noncommercial traders are not making moves that precede big price changes.

But congressional witnesses, among others, say that the CFTC misses trends involving large trades by swaps dealers acting on behalf of index investors and hedge funds because it lumps what little data it gets from Wall Street swaps dealers into a “commercial trader” category also encompassing airlines and oil refiners.

A CFTC study released last year showed that while commercial traders as a whole are net sellers, swaps dealers were typically net buyers of the near-term futures contracts that are quoted as the Nymex benchmark.

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  1. Anonymous

    “conflating factors”? Did you mean confounding factors?

    Love your blog Yves!

  2. fuguez

    There is no way that anyone has a handle on the size of the OTC market. They are private arrangements between two consenting adults. Until/unless there is regulation of OTC’s such that they must be centrally documented and cleared (as may well be made to happen in credit derivatives) then everyone (including the main players – GS, MSDW and BARC ) are simply guessing.

    One man’s speculator is another’s liquidity provider. People should simply grow up. There is a lot wrong with the financial markets at the moment and OTC commodity trading is simply not on that list – for now!

  3. RK

    I would be most grateful if someone could comment
    on the Michael Greenberger testimony to congress on “the London loophole” as it relates to CFTC non monitoring of offshore exchange based energy futures

  4. RK

    The location of the above is htttp://commerce.senate.gov/public/_files/img.June3testimonyO.pdf

  5. mxq

    RK, per money.com:

    “If speculation isn’t driving spot oil prices, the (new) laws would have no effect on them. But, to the extent that something funky is going on in the futures market, a clearer picture of the market’s participants and of oil’s true value would emerge. That might help an ailing economy.

    “You can’t solve the debate without looking at what’s happening,” says Greenberger. “Even people who accept the supply and demand argument, must accept that the markets are too opaque. We need to look at the data, so we can know for sure.”

  6. Juan

    It might be a good idea to not employ former lobbyists as regulators. Last August, Steven Briese made note that:

    Bart Chilton is the former chief lobbyist for National Farmers Union. Jill Sommers comes to the post from the International Swaps and Derivatives Association (ISDA), where she was the chief lobbyist. Swap dealers aren’t regulated by the CFTC. Why would the President appoint someone from the ISDA? Oh, ya, somebody needs to protect the status quo. The CFTC’s announcement is here. See my article on the influence of swap dealers in futures markets here.

    A number of worthwhile articles are available at same site.

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