Senate Considers Expanding Regulatory Power to Counter ‘Excessive Speculation’ in Gas Market

Michael Giberson

Proposals to increase government oversight of the energy markets, particularly over-the-counter trading, are unlikely to reduce volatility in those markets, some market analysts predict.

So begins a Dow Jones Newswire story on the reaction to the Senate Permanent Subcommittee on Investigations report on “excessive speculation” in natural gas markets. (I discussed the report here at Knowledge Problem last week.) The Senate will hold a hearing next week to further consider the recommendations put forward in that report for further regulation of natural gas trading.

Additional oversight of over-the-counter trading is unlikely to bring about any meaningful reduction in price spikes, since hedge funds and other large non-commercial buyers haven’t contributed significantly to natural gas market volatility, said George Hopley, a commodities strategist for Barclays Capital in New York. Hopley says increased speculation in the markets might actually curb large price swings by increasing liquidity in the markets.

“The risk takers have usually been on the opposite side of price spikes or downturns,” Hopley said. “They’ve helped market liquidity, and adding liquidity is a good thing to the extent that fundamentally, natural gas is a volatile commodity.”

Hopley’s comments reflect the standard economist’s wisdom about speculators (that they tend to buy low and sell high, thus stabilizing the market – if they didn’t they would be driven from the market). The other thing that economists tend to say is that price spikes are generally the least cost adjustment process to market conditions and in the absence of price spikes the market would face more complicated physical adjustments (shortages, non-price rationing, etc.).

It is unlikely that Hopley actually has the data necessary to assert his claims as an empirical matter, and by framing the issue as what effects speculators have had on the market he lends support to those seeking to expand government regulation of the over-the-counter market. After all, without additional regulatory reporting requirements, no one can routinely make informed decisions about what effects speculators are currently having on the market.

The more basic question is whether the current state of regulation is really resulting in public policy problems for which the best solution is the extension of government oversight. I don’t think the Amaranth Advisors blow up constitutes much evidence of a need for more regulation. Advocates of more regulation seem concerned that when Amaranth was told to reduce holdings on NYMEX, it moved it positions to ICE rather than simply unwinding them, but I must have missed the explanation of the harm to the public created by that switch.

Increased disclosure might improve the energy markets in some ways, said Michael Cosgrove, president of the Houston-based energy brokerage Amerex, a wholly owned division of derivatives broker GFI Group (GFIG). However, the markets tend to regulate themselves when it comes to issues of prudence, such as the size of a position an entity should take in a market, Cosgrove said.

“Regulators aren’t there to keep people from blowing themselves up,” Cosgrove said. “They’re there to ensure that the marketplaces are fair. Amaranth’s position was not too big for the market, it was too big for Amaranth.”

Just so. A problem for Amaranth’s investors certainly, but not a matter for expansion of government authority.