Energy panel debates hedge exemptions in final push on CFTC position limits

Washington — Energy sector interests generally welcomed the direction that the Commodity Futures Trading Commission set out in its fifth attempt to set federal position limits, but continued to press for refinements during an advisory panel meeting Thursday.

The commission in January voted 3-2 to propose new federal position limits in 25 physical commodity derivatives. It also expanded a list of listed hedges that would be expressly exempted and set out a streamlined process in which major exchanges could grant more exemptions, with a 10-day period for the CFTC to object or a two-day CFTC review for sudden hedging needs.

While agreeing the CFTC made headway by exempting more common commercial heading practices, and setting out a flexible process for exchanges to adapt as markets evolve, some energy interests continued to press for clarifications on what is exempted or sought further exclusions.

The Natural Gas Supply Association cautioned the CFTC against narrowing the definition of risk in its hedge exemption to encompass only price risk. "[W]e do know that investments in the production or consumption of a commodity include a variety of risks – price risk and operational, liquidity, credit and locational risk," said Jenny Fordham of NGSA. The trade group also argues that higher speculative positions allowed in natural gas cash-settled futures should not be conditioned on divesting of prompt-month physically settled futures contract positions.

Matthew Picardi of the Commercial Energy Working group broadly supported the new proposal's approach. He backed some added hedge exemptions, including those related to calendar month average pricing, basis differentials related to moving commodities across the supply chain from production to consumption, and hedging of storage.

PUSH FOR BROADER REACH

Still some energy consumers and smaller market players worried the exemptions may go too far, that the limits themselves were set too high, and that a wider net of transactions should be covered.

Sean Cota of New England Fuel Institute worried that the rule covers a limited subset of contracts and that a narrowed definition of economically equivalent swap would allow for easy avoidance of the limits. As to the proposal's focus on the spot month, he favored distributing limits across all markets.

Daniel Dunleavy of industrial energy consumer Ingevity called the proposal reasonable for the markets the CFTC is targeting but suggested the commission cast a wider net and increase its oversight of natural gas basis markets. "While the Henry Hub serves the purpose as a large benchmark, the fact remains that industrials are spread all over the United States and have a large exposure to basis," he said.

Separately, Tom LaSala of CME Group, which would play a key role in granting hedge exemptions, raised a practical concern about managing the requests. While he called the 12-month compliance timeframe broadly reasonable, he worried an influx of requests around the end of the 12-month period might be unmanageable for the exchange and suggested a rolling process as an alternative.

DELEGATING AUTHORITY

The balance of authority between the commission and the exchanges under the new rule continued to spark debate.

Commissioner Dan Berkovitz, the sponsor of the advisory committee, worried the CFTC would have too little time to weigh in on hedge exemptions that are granted by exchanges, as well as whether exchanges could provide sufficient transparency.

"After 10 years of rulemaking, [for] anything going forward, the exchanges will determine [exemptions], and we'll either have 10 days or two days for the commission to make its decision," he said.

"We have to have an appropriate balance here, between the authority of the exchanges and the authorities of the commission," he said, suggesting ultimately it is up to the CFTC to decide what is hedging and what is speculation.

Tyson Slocum of Public Citizen also continued to oppose delegating authorities to the exchanges.

"I think that we need more time to reflect on some of the lessons learned in the spectacular volatility and inefficiency that we've seen in oil markets, and what [was] the role of speculators and what potential role enhanced position limits could have played in making this market more efficient," Slocum added.

Along those lines, Berkovitz also suggested an analysis of trading positions and market liquidity leading up to and during the May WTI contract expiration could inform the CFTC on effectiveness of position limits as well as exchange-administered accountability limits.

Berkovits has suggested that if the WTI issues recur, the advisory panel could help the CFTC formulate next steps.