Comment Text:
10-002
COMMENT
CL-08246
From:
Sent:
To:
Subject:
Attach:
John F arr
Sunday, April 25, 2010 8:56 PM
secretary
Commodity Futures Trading Commission Proposed Federal Speculative Position
Limits
Comments on CFTC Speculative Position Limits.pdf
John Farr
65 Washington Street
Brooklyn, NY 11201
April 26, 2010
Mr. David Stawick, Secretary
Commodities Futures Trading Commission
Three Lafayette Centre
1155 21
st
Street, NW
Washington, DC 20581
[email protected]
Re: Commodity Futures Trading Commission Proposed Federal Speculative Position Limits, 17 CFR
Parts 1, 20 and 151:75 FR 4143 (Jan. 26, 2010)
Dear Mr. Stawick:
I would like to submit comments on the CFTC's proposal to impose all-months-combined, single-
month, and spot-month speculative position limits for contracts based on the NYMEX Henry Hub
natural gas contract, the NYMEX Light Sweet crude oil contract, the NYMEX New York Harbor No. 2
heating oil contract, and the NYMEX New York Harbor gasoline blendstock (RBOB) contract (the
"referenced contracts") and contracts based on the referenced contracts. As a consumer of natural gas,10-002
COMMENT
CL-08246
electricity, crude oil and gasoline based products, I applaud the CFTC for examining ways to minimize
or prevent the harmful effects of uncontrolled speculation, and
"to
insure fair practice and honest dealing
on commodity exchanges and provide a measure of control over those forms of speculative activity
which ...demoralize the markets to the injury of ...consumers .... " Clearly, in light of the recent
increases in commodity prices generally, and energy prices in particularly, along with the unusual
volatility in prices, this is a topic worthy of strong consideration. However, I would like to express some
concerns that the proposed rules could result in higher electricity, natural gas and energy prices for
consumers. My family purchases natural gas commodity from a gas marketer (in New York they are
called Energy Services Companies or ESCOs) under a fixed price contract which locks in my price of
gas for three years. I understand that the gas marketer is able to offer me this gas price certainty because
the marketer is able to hedge its natural gas commodity price risk in the futures markets. I am concerned
that limiting the marketer's ability to hedge its price risk will result in the marketer being unable to offer
me a fixed price contract and thus I would be exposed to natural gas price volatility, so that, for
example, if there is a hurricane in the Gulf of Mexico then my gas prices will increase significantly.
Additionally, I understand that my electric utility, ConEd, purchases natural gas to generate electricity
and any increases in natural gas prices will result in increased electricity bills for consumers since
electric utilities simply pass through their cost of purchasing electricity to the utility customers.
Similarly, any regulation that will impact crude oil and gasoline prices has a direct impact on consumers
of those commodities or products made with those commodities. We must remember that in our
economy any additional cost of doing business is passed on directly to consumers. For example, over the
last couple of years when wheat prices were increasing, there were signs in all of the pizza shops and
bakeries in my neighborhood informing customers of those shops of increases in prices of pizza, bread
and other goods made with wheat because of the increase in wheat prices. Also, most airlines have
increase air travel rates, imposed charges on baggage and instituted other fees and charges related to
increased fuel prices. Similarly, any additional cost to energy companies of doing business resulting
from additional regulations will be passed on to consumers.
Here are some pertinent passages from ConEd's annual financial report:
The company enters into certain derivative instruments relating to energy price hedging under
which the utility hedges market price fluctuations associated with physical purchases and sales of
electricity, natural gas, and steam by using derivative instruments including futures, forwards,
basis swaps, options, transmission congestion contracts and financial transmission rights
contracts. These derivative instruments represent economic hedges that mitigate exposure to
fluctuations in commodity prices.
In general, the Utilities recover their purchased power costs, including the cost of hedging
purchase prices, pursuant to rate provisions approved by the state public utility regulatory
authority having jurisdiction over the utility. Common provisions of the Utilities' rate plans may
include "Recoverable energy cost clauses" that allow the Utilities to recover on a current basis
the costs for the energy they supply. [The balance sheet and cash flow statement contain line
items for Recoverable energy cost.] The
Utilities generally recover all of their prudently incurred
fuel, purchased power and gas costs, including hedging gains and losses, in accordance with rate
provisions approved by the applicable state public utility commissions. If the actual energy
supply costs for a given month are more or less than the amounts billed to customers for that
month, the difference in most cases is recoverable from or refundable to customers. For the
Utilities' gas costs, differences between actual and billed gas costs during the 12-month period10-002
COMMENT
CL-08246
ending each August are charged or refunded to customers during a subsequent 12-month period.
Here is a quote from the CFTC's website:
Speculators do help make futures markets function better by providing liquidity, or the ability to
buy and sell futures contracts quickly without materially affecting the price.
Long and short
hedgers may not be sufficient to create a liquid futures market by themselves. The participation
of speculators willing to take the other side of hedgers' trades adds liquidity and makes it easier
for hedgers to hedge
It seems to me that reading these passages leads to a few observations. One, the state Public Service
Commission allows the utility to charge (recover from) me for the cost of purchasing electricity and gas.
Two, in that case it is prudent for my utility to hedge the cost of electricity and gas by entering into
derivative instruments to reduce the exposure to commodity price changes. Three, for the utility to enter
into these hedging transactions the utility needs speculators on the other side of the hedge transaction to
provide liquidity and make it easier for my utility to hedge and thereby reduce the cost of electricity and
gas. Four, if the CFTC imposes limits on the positions that speculators (who, it seems, should better be
referred to as liquidity providers) can hold then those limits probably will prevent speculators from
entering into hedging contracts, which means that there would be less liquidity in the energy markets,
the markets would not function better, and hedgers would not be able to buy and sell futures contracts
quickly without materially affecting prices. Five, this would drive up the cost of electricity and gas for
utility customers since fluctuations in the prices of those commodities would have more of an influence
on customers' electricity and gas bills.
Based upon some research and reading that I have done about these issues, it seems to me that the
CFTC's proposal to impose Federal Speculative Position Limits on the referenced contracts may reduce
liquidity in the market for those commodities. In the economics literature, it is generally accepted that in
markets high liquidity resulting from large numbers of contracts being traded is beneficial to market
participants. High liquidity shrinks the margin between the
bidprice
and the
ask price
(known as the
bid-ask spread)
and benefits both sides to a transaction. It is also generally accepted that in the energy
markets, liquidity dependents upon the existence of speculators who are willing to accept the price risk
that hedgers, like the utility, want to avoid and without speculators' participation, futures markets simply
would not exist. The speculators' participation in the market substantially enlarges the number of
potential buyers and sellers of commodities and therefore makes it easier for the utility to make firm
commitments for future delivery at a fixed price. The liquidity of a futures contract, upon which hedging
depends, is directly related to the amount of speculation that takes place.
As the Supreme Court observed in the case
of Merrill Lynch v. Curran:l[L]
The principal role of the speculator in the markets is to take the risks that the hedger is unwilling
to accept. The opportunity for profit makes the speculator willing to take those risks. The activity
of speculators is essential to the operation of a futures market, in that the composite bids and
offers of large numbers of individuals tend to broaden a market, thus making possible the10-002
COMMENT
CL-08246
execution with minimum price disturbance of the larger trade hedging orders.
By
increasing the
number of bids and offers available at any given price level, the speculator usually helps to
minimize price fluctuations, rather than to intensify them.
Without the trading activity of the
speculative fraternity, the liquidity, so badly needed in futures markets, simply would not exist.
Trading volume would be restricted materially, since, without a host of speculative orders in the
trading ring, many larger trade orders at limit prices would simply go unfilled due to the floor
broker's inability to find an equally large but opposing hedge order at the same price to complete
the match."
It is also generally agreed by economists that in a futures market with a large volume of trading, where
transactions occur in quick succession, the transaction cost of hedging tends to be quite small. While in a
futures market with very little trading the average transaction cost of hedging may be large, tending to
discourage the use of futures.
As stated above in the passages from my utility's annual financial report, electric and gas utilities are
exposed to fluctuations in the price of natural gas and thus face commodity price risk because the
electric utilities purchase large amounts of natural gas to generate power to serve the electricity needs of
the utilities' customers while gas utilities purchase gas to serve their customers' gas demand. Rising
natural gas prices directly results in higher electricity prices for electricity customers since the cost of
natural gas used to generate electricity is a component of the rates customers are charged for electricity
service. Additionally, rising natural gas prices results in higher cost to heat my house or cook my food
using natural gas. Therefore, it seems that it is prudent for electric and gas utilities, gas marketers and
other participants in the energy markets to hedge their commodity price risk to minimize their exposure
to spot-market price spikes. I mentioned earlier that airlines have imposed new and additional charges,
including fees for baggage. The one exception to this is Southwest airlines whose television ads tout the
fact that they do not charge baggage fees and I understand that the reason for this is that Southwest is
able to properly hedge its fuel cost. Proper hedging of price risk leads to lower energy commodity prices
and also lowers prices on other goods and services that depend on oil, gas, an other energy commodities.
It seems that the ability of energy companies to effectively hedge their exposure to price spikes depends
upon the existence of broad and liquid markets for energy products with small bid-ask spreads, minimal
price fluctuations and low transaction cost. I am concerned that speculative position limits on the
referenced energy contracts may impede the trading activities of my utility, the gas marketer from which
I purchase my natural gas and other businesses that depend on these commodities, and that this will
restrict trading volumes in those energy commodities, which will reduce liquidity, increase bid-ask
spreads, increase transaction costs, and even lead to increase price fluctuations which is what the CFTC
is trying to combat. These consequences will increase the cost of hedging natural gas exposure for my
utility and my gas marketer and result in higher electricity and natural gas bills for consumers. If
speculative position limits result in higher energy commodities price fluctuations then would that not
defeat the purpose of the proposed rules?
I appreciate the opportunity to comment on the proposed rule and urge the CFTC to carefully consider
imposing these rules so as to avoid increasing my electricity rates, natural gas commodity prices, oil and
gasoline prices.10-002
COMMENT
CL-08246
Sincerely,
John Farr
I[L] 456 U.S. 353,359 (1982).John Farr
65 Washington Street
Brooklyn, NY 11201
Mr. David Stawick, Secretary
Commodities Futures Trading Commission
Three Lafayette Centre
1155 21
st
Street, NW
Washington, DC 20581
[email protected]
April 26, 2010
Commodity Futures Trading Commission Proposed Federal Speculative Position Limits,
17 CFR Parts 1, 20 and 151; 75 FR 4143 (.Jan. 26, 2010)
Dear Mr. Stawick:
I would like to submit comments on the CFTC's proposal to impose all-months-combined,
single-month, and spot-month speculative position limits for contracts based on the NYMEX
Henry Hub natural gas contract, the NYMEX Light Sweet crude oil contract, the NYMEX New
York Harbor No. 2 heating oil contract, and the NYMEX New York Harbor gasoline blendstock
(RBOB) contract (the "referenced contracts") and contracts based on the referenced contracts. As
a consumer of natural gas, electricity, crude oil and gasoline based products, I applaud the CFTC
for examining ways to minimize or prevent the harmful effects of uncontrolled speculation, and
"to insure fair practice and honest dealing on commodity exchanges and provide a measure of
control over those forms of speculative activity which ... demoralize the markets to the injury of
...consumers .... " Clearly, in light of the recent increases in commodity prices generally, and
energy prices in particularly, along with the unusual volatility in prices, this is a topic worthy of
strong consideration. However, I would like to express some concerns that the proposed rules
could result in higher electricity, natural gas and energy prices for consumers. My family
purchases natural gas commodity from a gas marketer (in New York they are called Energy
Services Companies or ESCOs) under a fixed price contract which locks in my price of gas for
three years. I understand that the gas marketer is able to offer me this gas price certainty because
the marketer is able to hedge its natural gas commodity price risk in the futures markets. I am
concerned that limiting the marketer's ability to hedge its price risk will result in the marketer
being unable to offer me a fixed price contract and thus I would be exposed to natural gas price
volatility, so that, for example, if there is a hurricane in the Gulf of Mexico then my gas prices
will increase significantly. Additionally, I understand that my electric utility, ConEd, purchases
natural gas to generate electricity and any increases in natural gas prices will result in increased
electricity bills for consumers since electric utilities simply pass through their cost of purchasing
electricity to the utility customers. Similarly, any regulation that will impact crude oil and
gasoline prices has a direct impact on consumers of those commodities or products made with
those commodities. We must remember that in our economy any additional cost of doing
business is passed on directly to consumers. For example, over the last couple of years when
wheat prices were increasing, there were signs in all of the pizza shops and bakeries in myneighborhood informing customers of those shops of increases in prices of pizza, bread and other
goods made with wheat because of the increase in wheat prices. Also, most airlines have increase
air travel rates, imposed charges on baggage and instituted other fees and charges related to
increased fuel prices. Similarly, any additional cost to energy companies of doing business
resulting from additional regulations will be passed on to consumers.
Here are some pertinent passages from ConEd's annual financial report:
The company enters into certain derivative instruments relating to energy price hedging
under which the utility hedges market price fluctuations associated with physical
purchases and sales of electricity, natural gas, and steam by using derivative instruments
including futures, forwards, basis swaps, options, transmission congestion contracts and
financial transmission rights contracts. These derivative instruments represent economic
hedges that mitigate exposure to fluctuations in commodity prices.
In general, the Utilities recover their purchased power costs, including the cost of
hedging purchase prices, pursuant to rate provisions approved by the state public utility
regulatory authority having jurisdiction over the utility. Common provisions of the
Utilities' rate plans may include "Recoverable energy cost clauses" that allow the
Utilities to recover on a current basis the costs for the energy they supply. [The balance
sheet and cash flow statement contain line items for Recoverable energy cost.] The
Utilities generally recover all of their prudently incurred fuel, purchased power and gas
costs, including hedging gains and losses, in accordance with rate provisions approved by
the applicable state public utility commissions. If the actual energy supply costs for a
given month are more or less than the amounts billed to customers for that month, the
difference in most cases is recoverable from or refundable to customers. For the Utilities'
gas costs, differences between actual and billed gas costs during the 12-month period
ending each August are charged or refunded to customers during a subsequent 12-month
period.
Here is a quote from the CFTC's website:
Speculators do help make futures markets function better by providing liquidity, or the
ability to buy and sell futures contracts quickly without materially affecting the price.
Long and short hedgers may not be sufficient to create a liquid futures market by
themselves. The participation of speculators willing to take the other side of hedgers'
trades adds liquidity and makes it easier for hedgers to hedge
It seems to me that reading these passages leads to a few observations. One, the state Public
Service Commission allows the utility to charge (recover from) me for the cost of purchasing
electricity and gas. Two, in that case it is prudent for my utility to hedge the cost of electricity
and gas by entering into derivative instruments to reduce the exposure to commodity price
changes. Three, for the utility to enter into these hedging transactions the utility needs
speculators on the other side of the hedge transaction to provide liquidity and make it easier for
my utility to hedge and thereby reduce the cost of electricity and gas. Four, if the CFTC imposes
limits on the positions that speculators (who, it seems, should better be referred to as liquidity
providers) can hold then those limits probably will prevent speculators from entering into
hedging contracts, which means that there would be less liquidity in the energy markets, themarkets would not function better, and hedgers would not be able to buy and sell futures
contracts quickly without materially affecting prices. Five, this would drive up the cost of
electricity and gas for utility customers since fluctuations in the prices of those commodities
would have more of an influence on customers' electricity and gas bills.
Based upon some research and reading that I have done about these issues, it seems to me that
the CFTC's proposal to impose Federal Speculative Position Limits on the referenced contracts
may reduce liquidity in the market for those commodities. In the economics literature, it is
generally accepted that in markets high liquidity resulting from large numbers of contracts being
traded is beneficial to market participants. High liquidity shrinks the margin between the
bid
price
and the
askprice
(known as the
bid-ask spread)
and benefits both sides to a transaction. It
is also generally accepted that in the energy markets, liquidity dependents upon the existence of
speculators who are willing to accept the price risk that hedgers, like the utility, want to avoid
and without speculators' participation, futures markets simply would not exist. The speculators'
participation in the market substantially enlarges the number of potential buyers and sellers of
commodities and therefore makes it easier for the utility to make firm commitments for future
delivery at a fixed price. The liquidity of a futures contract, upon which hedging depends, is
directly related to the amount of speculation that takes place.
As the Supreme Court observed in the case of
Merrill Lynch v. Curran:
1
The principal role of the speculator in the markets is to take the risks that the hedger is
unwilling to accept. The opportunity for profit makes the speculator willing to take those
risks. The activity of speculators is essential to the operation of a futures market, in that
the composite bids and offers of large numbers of individuals tend to broaden a market,
thus making possible the execution with minimum price disturbance of the larger trade
hedging orders.
B
v
increasin~ the number of bids and offers available at an
v
~iven
price level~ the speculator usuall
v
helps to minimize price fluctuations~ rather than
to intensify them.
Without the trading activity of the speculative fraternity, the liquidity,
so badly needed in futures markets, simply would not exist. Trading volume would be
restricted materially, since, without a host of speculative orders in the trading ring, many
larger trade orders at limit prices would simply go unfilled due to the floor broker's
inability to find an equally large but opposing hedge order at the same price to complete
the match."
It is also generally agreed by economists that in a futures market with a large volume of trading,
where transactions occur in quick succession, the transaction cost of hedging tends to be quite
small. While in a futures market with very little trading the average transaction cost of hedging
may be large, tending to discourage the use of futures.
As stated above in the passages from my utility's annual financial report, electric and gas utilities
are exposed to fluctuations in the price of natural gas and thus face commodity price risk because
the electric utilities purchase large amounts of natural gas to generate power to serve the
electricity needs of the utilities' customers while gas utilities purchase gas to serve their
customers' gas demand. Rising natural gas prices directly results in higher electricity prices for
electricity customers since the cost of natural gas used to generate electricity is a component of
1
456 U.S. 353,359 (1982).the rates customers are charged for electricity service. Additionally, rising natural gas prices
results in higher cost to heat my house or cook my food using natural gas. Therefore, it seems
that it is prudent for electric and gas utilities, gas marketers and other participants in the energy
markets to hedge their commodity price risk to minimize their exposure to spot-market price
spikes. I mentioned earlier that airlines have imposed new and additional charges, including fees
for baggage. The one exception to this is Southwest airlines whose television ads tout the fact
that they do not charge baggage fees and I understand that the reason for this is that Southwest is
able to properly hedge its fuel cost. Proper hedging of price risk leads to lower energy
commodity prices and also lowers prices on other goods and services that depend on oil, gas, an
other energy commodities. It seems that the ability of energy companies to effectively hedge
their exposure to price spikes depends upon the existence of broad and liquid markets for energy
products with small bid-ask spreads, minimal price fluctuations and low transaction cost. I am
concerned that speculative position limits on the referenced energy contracts may impede the
trading activities of my utility, the gas marketer from which I purchase my natural gas and other
businesses that depend on these commodities, and that this will restrict trading volumes in those
energy commodities, which will reduce liquidity, increase bid-ask spreads, increase transaction
costs, and even lead to increase price fluctuations which is what the CFTC is trying to combat.
These consequences will increase the cost of hedging natural gas exposure for my utility and my
gas marketer and result in higher electricity and natural gas bills for consumers. If speculative
position limits result in higher energy commodities price fluctuations then would that not defeat
the purpose of the proposed rules?
I appreciate the opportunity to comment on the proposed rule and urge the CFTC to carefully
consider imposing these rules so as to avoid increasing my electricity rates, natural gas
commodity prices, oil and gasoline prices.
Sincerely,
John Farr
