The fight over whether over-the-counter nonphysical trades in oil and gas futures deliberately or incidentally make energy prices volatile continues to rage in the halls of Congress.

In August, the Federal Trade Commission (FTC) issued its final rule, to take effect November 4, 2009, regarding fraudulent manipulation of wholesale oil markets. The rule, Subtitle B of Title VII of The Energy Independence and Security Act of 2007, increases the penalty to $1 million per violation per day, up from $11,000, for entities that make untrue statements of material fact or intentionally fail to state a material fact that would distort crude oil, gasoline or petroleum distillates prices in exchange markets. Natural gas trades are already covered under the Energy Policy Act of 2005.

Violations include false statements about oil production or pricing, and “wash sales,” defined as the purchase or sale of a commodity when no change of ownership occurs.

However, some opponents have urged the Commission to recognize the realities of normal business practices in wholesale petroleum markets “so as to avoid crafting a rule that unduly chills legitimate business conduct.”

Also, an onerous compliance program could curtail voluntary disclosures, thereby denying the markets information.

Last year, Congress passed a provision in the 2008 Farm Bill to allow the Commodity Futures Trading Commission (CFTC) to regulate previously exempt Intercontinental Exchange contracts, such as Henry Hub gas swaps. In August 2009, the CFTC began to seriously consider exercising its authority by imposing position limits and trading caps to try to reduce unregulated trades that could detrimentally manipulate gas prices.

Stakeholders, from hedge fund managers to energy associations, have opposed such actions. John Arnold, head of the $5-billion hedge fund, Centaurus Advisors, addressing the CFTC in Washington on August 5, said, “Position limits on financial contracts will decrease liquidity, increase transaction costs and increase volatility associated with expiration.” Limits set to go into effect next month on the Nymex for financially settled gas contracts should be rescinded, he said.

Barry Russell, president and chief executive of IPAA, said in a letter to House Speaker Nancy Pelosi, that “a clear distinction must be drawn between producers, who seek to minimize price risk through responsible hedging practices, and speculators, such as hedge funds, that seek to profit from price volatility.”

He further noted that, under the bill, producers would be prohibited from hedging with their banks and would be “forced to trade directly with the exchanges, which would require producers to post cash collateral twice daily, based on mark-to-market value of their hedges.” Such a provision would cripple producers’ hedging programs, because exchanges do not accept letters of credit or mortgages on gas and oil properties, but require cash or collateral.

In recent years, oil and gas producers are increasingly hedging to stabilize cash flow, and the programs are even more critical during recessions such as began last year.

In its second-quarter 2009 earnings release, Petrohawk Energy Corp. stated it had gained $2.34 per thousand cubic feet (Mcf) of gas from hedging, bringing realized gas prices to $5.62 per Mcf.

Also, Range Resources Corp. revealed its hedging success for the second quarter. “For the balance of the year, approximately 80% of our natural gas production is hedged at an average floor price of $7.49 per Mcf, providing significant cash flow protection.”

Meanwhile, banking firms such as JP Morgan and Goldman Sachs argue that position limits could push investors to hedge on foreign exchanges, and the CFTC would have to work with foreign exchanges to create uniform standards.

To comply with the new CFTC rules, the Intercontinental Exchange said it is reducing its Henry Hub gas swap products, now subject to position limits, where previously it provided an unlimited investment vehicle for traders whose Nymex position had grown too large.

In advance of proposed position limits, the United States Natural Gas Exchange Traded Fund (UNG) announced in July it will reduce its position in the gas futures market to comply with new federal limits. Until now, UNG accounted for about 30% of the gas futures market, having grown from about $727 million in assets under management in the first quarter to about $4.5 billion in July.

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