<DOC>
[110 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:40506.wais]
S. Hrg. 110-382
SPECULATION IN THE CRUDE OIL MARKET
=======================================================================
JOINT HEARING
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
and the
SUBCOMMITTEE ON ENERGY
of the
COMMITTEE ON ENERGY AND NATURAL RESOURCES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
----------
DECEMBER 11, 2007
----------
Available via http://www.access.gpo.gov/congress/senate
Printed for the use of the
Committee on Homeland Security and Governmental Affairs
U.S. GOVERNMENT PRINTING OFFICE
40-506 WASHINGTON : 2008
----------------------------------------------------------------------
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COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii TED STEVENS, Alaska
THOMAS R. CARPER, Delaware GEORGE V. VOINOVICH, Ohio
MARK PRYOR, Arkansas NORM COLEMAN, Minnesota
MARY L. LANDRIEU, Louisiana TOM COBURN, Oklahoma
BARACK OBAMA, Illinois PETE V. DOMENICI, New Mexico
CLAIRE McCASKILL, Missouri JOHN WARNER, Virginia
JON TESTER, Montana JOHN E. SUNUNU, New Hampshire
Michael L. Alexander, Staff Director
Brandon L. Milhorn, Minority Staff Director and Chief Counsel
Trina Driessnack Tyrer, Chief Clerk
------
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
CARL LEVIN, Michigan, Chairman
THOMAS R. CARPER, Delaware NORM COLEMAN, Minnesota
MARK L. PRYOR, Arkansas TOM COBURN, Oklahoma
BARACK OBAMA, Illinois PETE V. DOMENICI, New Mexico
CLAIRE McCASKILL, Missouri JOHN WARNER, Virginia
JON TESTER, Montana JOHN E. SUNUNU, New Hampshire
Elise J. Bean, Staff Director and Chief Counsel
Dan M. Berkovitz, Counsel
Mark L. Greenblatt, Staff Director and Chief Counsel to the Minority
Mark D. Nelson, Deputy Chief Counsel to the Minority
Mary D. Robertson, Chief Clerk
------
COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon LISA MURKOWSKI, Alaska
TIM JOHNSON, South Dakota RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana JIM DeMINT, South Carolina
MARIA CANTWELL, Washington BOB CORKER, Tennessee
KEN SALAZAR, Colorado JOHN BARRASSO, Wyoming
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
Angela Becker-Dippmann, Professional Staff Member
Melissa Shute, Republican Counsel
------
Subcommittee on Energy
BYRON L. DORGAN, North Dakota, Chairman
DANIEL K. AKAKA, Hawaii LISA MURKOWSKI, Alaska
RON WYDEN, Oregon LARRY E. CRAIG, Idaho
TIM JOHNSON, South Dakota RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana JIM DeMINT, South Carolina
MARIA CANTWELL, Washington BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Jeff Bingaman and Pete V. Domenici are Ex Officio Members of the
Subcommittee
C O N T E N T S
------
Opening statements:
Page
Senator Levin................................................ 1
Senator Dorgan............................................... 8
Senator Coleman.............................................. 11
Senator Murkowski............................................ 14
Senator Collins.............................................. 18
Senator Wyden................................................ 20
Senator Craig................................................ 22
Senator Barrasso............................................. 23
Senator Cantwell............................................. 24
Senator Menendez............................................. 25
Senator McCaskill............................................ 26
Prepared statements:
Senator Tester............................................... 22
Senator Bingaman............................................. 61
Senator Salazar.............................................. 61
WITNESSES
Tuesday, December 11, 2007
Guy F. Caruso, Administrator, U.S. Energy Information
Administration, U.S. Department of Energy...................... 27
Fadel Gheit, Managing Director and Senior Oil Analyst,
Oppenheimer & Co., Inc., New York, New York.................... 29
Edward N. Krapels, Special Advisor, Financial Energy Market
Services, Energy Security Analysis, Inc., Wakefield,
Massachusetts.................................................. 30
Philip K. Verleger, Jr., President, PK Verleger, LLC, Aspen,
Colorado....................................................... 32
Alphabetical List of Witnesses
Caruso, Guy F.:
Testimony.................................................... 27
Prepared statement with attachments.......................... 67
Gheit, Fadel:
Testimony.................................................... 29
Prepared statement........................................... 76
Krapels, Edward N.:
Testimony.................................................... 30
Prepared statement........................................... 78
Verleger, Philip K. Jr.:
Testimony.................................................... 32
Prepared statement........................................... 98
APPENDIX
Charts submitted for the Record by Senator Levin................. 63
EXHIBITS
1. GCrude Oil Prices (NYMEX), Jan 2002-Dec 2007, chart prepared
by the Majority Staff, Senate Permanent Subcommittee on
Investigations................................................. 118
2. GU.S. Crude Oil Inventories, 2007 Compared to Previous 5-Year
Average, chart prepared by the Majority Staff, Senate Permanent
Subcommittee on Investigations................................. 119
3. GCrude Oil Futures and Options, Speculative Positions, 2002-
2007, chart prepared by the Majority Staff, Senate Permanent
Subcommittee on Investigations................................. 120
4. GU.S. Crude Oil: Prices and Inventories at Cushing, OK, 2007,
chart prepared by the Majority Staff, Senate Permanent
Subcommittee on Investigations................................. 121
5. GWhy Are Oil Prices So High?, This Week In Petroleum, Energy
Information Administration, November 7, 2007................... 122
6. GDistorting a Benchmark, International Energy Agency--Oil
Market Report, April 12, 2007.................................. 127
7. GTrends in Hedge Fund Industry Assets and Oil Prices, chart
prepared by Office of Senator Byron Dorgan..................... 128
8. GDecrease in the Price of Saudi Light Relative to WTI Since
May 2007, chart prepared by Office of Senator Byron Dorgan..... 129
9. GThe Role of Market Speculation In Rising Oil And Gas Prices:
A Need To Put The Cop Back On The Beat, Staff Report prepared
by the Permanent Subcommittee on Investigations of the
Committee on Homeland Security and Governmental Affairs, June
27, 2006....................................................... 130
10. GLetter to The Honorable Samuel W. Bodman, Secretary, U.S.
Department of Energy, October 18, 2007, from Senators Levin,
Wyden, Bingaman, Reed, McCaskill, Dorgan and Kerry, regarding
the Strategic Petroleum Reserve................................ 182
11. GSTEO Supplement: Why are oil prices so high?, Energy
Information Administration/Short Term Energy Outlook, August
2006........................................................... 184
12. GShort-Term Energy Outlook Supplement: Why Are Oil Prices So
High?, Energy Information Administration/Short-Term Energy
Outlook Supplement--November 2007.............................. 191
13. GU.S. Commodity Futures Trading Commission press releases.... 197
14. GSpeculative Interest in Crude Oil (Percent of Open Interest
Held by Speculators), chart prepared by the Majority Staff,
Senate Permanent Subcommittee on Investigations................ 201
15. GCrude Oil Futures Contracts, Open Interest, NYMEX, 2002-07,
chart prepared by the Majority Staff, Senate Permanent
Subcommittee on Investigations................................. 202
16. G$100 oil and the `S' word, quote from CCNMoney.com, chart
prepared by Office of Senator Byron Dorgan..................... 203
17. GU.S. Crude Oil Stocks, chart prepared by Office of Senator
Byron Dorgan................................................... 204
18. GQuotes from October 21, 2007 Washington Post story by David
Cho, Energy Traders Avoid Scrutiny, chart prepared by Office of
Senator Byron Dorgan........................................... 205
19. GLetter to the U.S. Senate Energy and Natural Resources
Committee, dated December 11, 2007, from Dr. Bert Zauderer,
Coal Tech Corp, regarding oil and gas data..................... 206
20. Ga. and b. Inserts for the hearing record from The Honorable
Guy F. Caruso, Administrator, Energy Information
Administration, U. S. Department of Energy..................... 208
21. GResponses to supplemental questions for the record submitted
to The Honorable Guy F. Caruso, Administrator, U.S. Energy
Information Administration, U. S. Department of Energy......... 211
22. GResponses to supplemental questions for the record submitted
to Fadel Gheit, Managing Director and Senior Energy Analyst,
Oppenheimer & Co. Inc.......................................... 230
23. GResponses to supplemental questions for the record submitted
to Edward N. Krapels, Special Advisor, Financial Energy Market
Services, Energy Security Analysis, Inc........................ 235
24. GResponses to supplemental questions for the record submitted
to Philip K. Verleger, Jr., President, PK Verleger, LLC........ 240
SPECULATION IN THE CRUDE OIL MARKET
----------
TUESDAY, DECEMBER 11, 2007
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Joint hearing with the Subcommittee on Energy,
Committee on Energy and Natural Resources,
Washington, DC.
The Subcommittees met, pursuant to notice, at 10:03 a.m.,
in Room 216, Hart Senate Office Building, Hon. Carl Levin,
Chairman of the Permanent Subcommittee on Investigations,
Committee on Homeland Security and Governmental Affairs, and
Hon. Byron L. Dorgan, Chairman of the Subcommittee on Energy,
Committee on Energy and Natural Resources presiding.
Present: Senators Levin, McCaskill, Tester, Coleman,
Collins, Dorgan, Wyden, Cantwell, Menendez, Bingaman, Salazar,
Murkowski, Craig, Corker, and Barrasso.
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good morning, everybody. The Permanent
Subcommittee on Investigations and the Subcommittee on Energy
are conducting a joint hearing this morning into why U.S. oil
prices keep rising despite what appears to be an adequate U.S.
supply of oil.
The price of crude oil recently rose above $99 per barrel,
a record high. Just before Thanksgiving, the national average
price of gasoline went over $3.10 per gallon for the second
time this year. The price of diesel fuel is at a record high,
as is the price of home heating oil. These record high prices
severely hurt millions of Americans and American businesses.
They raise the cost of virtually everything in our daily
lives--the gasoline in our cars and trucks, the food we eat,
air travel, heating our homes and offices, generating
electricity, and manufacturing countless industrial and
consumer products. It is our duty in Congress to do everything
that we can to ensure that the price Americans pay for energy
is a fair price.
Just about a year ago, on January 18, 2007, the price of
crude oil on the New York Mercantile Exchange (NYMEX), was
about $50 per barrel. A few weeks ago, the NYMEX price reached
an all-time high of just over $99 per barrel. The chart to my
left, Exhibit 1, shows that huge increase in the price of
oil.\1\
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\1\ See Exhibit No. 1, which appears in the Appendix on page 118.
---------------------------------------------------------------------------
And although the price of oil virtually doubled during this
period, an unprecedented rise of nearly $50 in just 1 year, the
overall inventory of oil in the United States has been above
the 5-year average for the entire year. Exhibit 2 shows the way
that inventory has remained above the 5-year average.\1\ It
just defies the laws of supply and demand to have an
astronomical increase in the price of oil at the same time the
U.S. inventory of oil has stayed above average.
---------------------------------------------------------------------------
\1\ See Exhibit No. 2, which appears in the Appendix on page 119.
---------------------------------------------------------------------------
On any given day, we can read in the newspapers or hear on
the television the familiar explanations for why the price of
oil is so high--instability in the Middle East, bad weather
affecting oil production platforms, civil strife in oil-
producing countries, the declining value of the dollar. These
are just a few of the ``usual suspects'' that are often cited
as the reasons for high prices.
The problem with these explanations is not that they are
false. Most of them are true. But most of them have been true
for some time. Unfortunately, instability in the Middle East is
not new. There is always bad weather somewhere around the globe
that affects oil production and transportation. There is,
unfortunately, a lot of civil strife in a number of oil-
producing countries. The dollar rises and the dollar falls. The
world is a dangerous place. These factors alone cannot justify
a doubling in the price of oil.
So what else can help explain these record prices? In this
hearing, we will examine some of the other factors that are
contributing to the high price of oil as well as what we can do
about it.
One key factor that has contributed to the rise in oil
prices over the past few years is the virtual explosion of
trading of paper contracts for oil delivery in future months,
trading which is speculative and not intended to result in the
actual delivery of oil. Traders are trading paper oil contracts
in record amounts. In the last 4 years, we have seen a huge
increase in the number of oil futures contracts traded in the
New York Mercantile Exchange, and there has also been
tremendous growth of trading of U.S. crude oil in London. As
Secretary of Energy Bodman recently said, the prices for crude
oil are now set in New York, London, Tokyo, Singapore, and
other trading hubs around the world.
Data compiled by the Commodity Futures Trading Commission
(CFTC), shows that in the past few years, out of this overall
increase in energy trading, the amount of trading due to
speculation has nearly tripled. Chart 3--that is Exhibit 14 \2\
in the exhibit book--shows that in the last few years, the
percentage of oil futures contracts held by speculators has
risen from around 15 percent to nearly 45 percent. These are
traders who are solely interested in trading for a profit
rather than hedging their positions to assure a stable supply
at a price that they can count on. These energy speculators not
only comprise a larger percentage of U.S. oil trades, but are
also responsible for a larger dollar amount involved in U.S.
energy commodity trades.
---------------------------------------------------------------------------
\2\ See Exhibit No. 14, which appears in the Appendix on page 201.
---------------------------------------------------------------------------
A fair price is a price that reflects the forces of supply
and demand for a commodity, not the trading strategies of
speculators who are only in the market to make a profit by
buying and selling of paper contracts with no intent to
actually purchase, deliver, or transfer the commodity. But as
we have all too often seen in recent years, when speculation
grows so large that it has a major impact on the market, prices
get distorted and stop reflecting true supply and demand.
Last year, our Subcommittee released a bipartisan report
called ``The Role of Market Speculation in Rising Oil and Gas
Prices: A Need to Put the Cop Back on the Beat.'' \1\ The
report found that trading of futures contracts by speculators
had increased the demand for oil futures, and this additional
demand for contracts had contributed an additional $20 to the
price of oil. At the time, the price of oil was about $70 per
barrel, so speculation was a major contributor to what was then
thought to be sky-high crude oil prices. Our report recommended
additional market transparency and stronger market oversight to
reduce the effects of increased speculation.
---------------------------------------------------------------------------
\1\ See Exhibit No. 9, which appears in the Appendix on page 130.
---------------------------------------------------------------------------
Given the hefty increases in speculation in the U.S. oil
market, we need to know what the effect of all this speculation
has been on U.S. oil prices. To what extent, for example, has
dramatically increased speculation contributed to the
extraordinary jump in prices that we have seen this year? Is
speculation responsible for about $20 per barrel of oil or
more? This is a vitally important question. If the
extraordinary increase in oil prices is not based on actual
supply and demand, then we need to figure out what role is
being played by speculation and what steps can be taken to
restore the market's focus on supply and demand.
Speculation is not, of course, the only reason for sky-high
oil prices in 2007. One additional key reason that we want to
examine is the policy of the Administration relative to adding
oil to the Strategic Petroleum Reserve (SPR). One of today's
witnesses, Dr. Philip Verleger, will present his analysis of
how the Administration's program to fill the SPR with high-
quality crude oil, known as sweet crude, has contributed to the
recent price increases. He will tell us how the SPR fill
program has helped deplete supplies of sweet crude normally
used to fulfill crude oil futures contracts traded on the NYMEX
and how those reduced supplies have, in turn, pushed up crude
oil prices.
There is a third problem, as well, that the SPR fill
program has exacerbated. The fact that the standard NYMEX
futures contract that sets the benchmark price for U.S. crude
oil requires a particular type of high-quality crude oil known
as West Texas Intermediate (WTI), to be delivered at a
particular location, which happens to be Cushing, Oklahoma.
Because the price of the standard contract depends upon the
supply of WTI, which again is but one type of sweet crude oil,
the supply and demand conditions in Oklahoma have a
disproportionate influence on the price of NYMEX futures
contracts. Four years ago, I called for reform of this outdated
feature of the standard NYMEX crude contract, but it has never
been fixed and the problems caused by the standard contract
have gotten worse.
The next chart, which is Exhibit 4, shows that in 2007, the
crude oil inventory in Cushing, Oklahoma, fell.\1\ When that
inventory crashed, it caused a big supply drop in Oklahoma,
even though overall U.S. crude oil inventories remained above
average. But because the Oklahoma supply fell, the benchmark
price on the NYMEX jumped, since again the NYMEX price depends
on the supply and demand for oil at Cushing, Oklahoma.
---------------------------------------------------------------------------
\1\ See Exhibit No. 4, which appears in the Appendix on page 121.
---------------------------------------------------------------------------
According to Dr. Verleger, it is only sweet crude oil that
now is in relatively short supply compared to demand, and that
is part of the reason why oil on the NYMEX has become so
expensive. Indeed, last month, the difference in price between
sweet crude oil and some other types of crude oils reached $20,
$30, or even $40 per barrel in U.S. trading. That is a pretty
striking price gap.
Why does it matter that the Administration is depositing
sweet crude into the SPR? It matters because the price of one
key type of sweet crude, WTI, determines the price of the
standard NYMEX contract. The standard NYMEX contract price, in
turn, is a major influence on the price of fuels refined from
crude oil, such as gasoline, heating oil, and diesel. That
means when the WTI price is no longer representative of the
price of U.S. crude oil in general, the prices of all these
other commodities are also thrown out of whack.
And the Department of Energy has made the situation much
worse by purchasing several million barrels of sweet crude and
depositing them into the SPR over the past few months. Those
purchases removed sweet crude from the marketplace and reduced
the supply of oil available for WTI contracts. And as you can
see from this chart,\1\ the drop of several million barrels in
the inventory of crude oil at Cushing since August has been
accompanied by a huge increase in the price of U.S. crude oil.
It seems that the only place in the United States where price
really reflects supply and demand is in Cushing, Oklahoma.
In the last 4 months, DOE has taken several million barrels
of sweet crude off the market to fill the SPR, regardless of
price. If DOE had simply postponed the SPR fill for 1 year, it
would not only have alleviated the upward pressure on U.S. oil
prices, but also saved U.S. taxpayers millions of dollars.
Based on the market and futures prices at the time the DOE
bought oil for the SPR, DOE could have saved $10 per barrel by
simply locking in the futures price and deferring current
deliveries for 1 year. That is because at the time the oil was
acquired, the futures price for delivering the oil in 1 year
was about $10 per barrel cheaper than the current price. Since
the Administration bought enough oil to deposit another 8.7
million barrels in the SPR, that $10 million price difference
would have translated into a 1-year taxpayer savings of nearly
$87 million.
In light of Congress's direction in the Energy Policy Act
of 2005 to fill the SPR in a manner that minimizes costs to
taxpayers and minimizes impacts on oil prices, it is
incomprehensible why DOE continues to fill the SPR without
taking advantage of the lower futures prices when they exist.
This state of affairs raises two questions. First, why is
DOE contributing to the shortage of sweet crude oil by placing
it into the SPR and thereby helping boost the standard NYMEX
price? What's worse, it is our understanding that the DOE
intends to deposit another 7 million barrels of sweet crude oil
into the SPR beginning next month. DOE will be taking this
high-quality oil off the market just at the time when it will
be in the highest demand to produce gasoline and diesel fuel
for the spring and summer driving seasons.
Second, it appears that we have an oil futures market that
reflects the supply and demand conditions in Oklahoma, but not
necessarily the overall supply and demand situation in the
United States as a whole. Our Subcommittee raised this very
issue in 2003 and called on the CFTC and NYMEX to work together
to revise the standard NYMEX crude oil futures contract to
reduce its susceptibility to local imbalances in the market for
WTI crude oil. The Subcommittee report suggested that allowing
for delivery at other locations could reduce the volatility of
the contract. It is truly disappointing that since our report
was issued, no progress has been made in allowing for delivery
in other places than Cushing. Again, the price of oil to our
consumers is higher because of that failure.
The final problem is that a large portion of trading of WTI
crude oil now takes place in London, regulated by the British
authorities under British law. How can we really know what is
influencing our oil markets when we can't see all the market
data? Although the CFTC has a data sharing agreement with the
British authorities, none of this data is available to the
public. Unlike the U.S. oil futures market, there is no public
data on how much of the trading occurring in London is done by
speculators. So a key issue is how can we improve the
transparency of the crude oil market?
In addition to stopping the SPR fill, fixing the NYMEX
contract, and getting information about WTI trades in London, a
number of us have introduced the Close the Enron Loophole Act
to improve the transparency of U.S. energy markets. Our bill
would give the CFTC the authority to police what are now
unregulated electronic trading markets for large energy
traders. This vitally needed legislation is more important
right now for natural gas prices, but there is nothing
preventing crude oil contracts from being traded on unregulated
electronic markets, as well, and which took place until
recently. Many of us are working together to pass this
legislation as part of the farm bill.
All of our witnesses today are very knowledgeable about the
oil markets. I thank all of them for their willingness to
testify at this joint hearing and we all look forward to their
testimony.
I would also like to express particularly my appreciation
to the Ranking Member of the Permanent Subcommittee, Senator
Coleman, and his staff for their support in organizing this
hearing, and to our colleagues on the Senate Energy Committee
for working together with us to conduct this joint hearing. In
particular, I want to thank Senators Dorgan and Murkowski of
the Subcommittee on Energy for all of their efforts. The price
of oil is an important issue for all of us and our
constituents, as it affects virtually every aspect of our
economy. I am glad that we have worked together so closely so
that we can focus our witnesses and our attention in a single
forum where this issue can be examined.
[The prepared statement of Senator Levin follows:]
OPENING STATEMENT OF SENATOR CARL LEVIN
Good morning. The Permanent Subcommittee on Investigations and the
Subcommittee on Energy are conducting a joint hearing into why U.S. oil
prices keep rising despite what appears to be an adequate U.S. supply
of oil.
The price of crude oil recently rose above $99 per barrel, a record
high. Just before Thanksgiving, the national average price of gasoline
went over $3.10 per gallon for the second time this year. The price of
diesel fuel is at a record high, as is the price of home heating oil.
These record high prices severely hurt millions of Americans and
American businesses. They raise the cost of virtually everything in our
daily lives--the gasoline in our cars and trucks, the food we eat, air
travel, heating our homes and offices, generating electricity, and
manufacturing countless industrial and consumer products. It is our
duty in the Congress to do everything we can to ensure that the price
Americans pay for energy is a fair price.
Just about a year ago, on January 18, the price of crude oil on the
New York Mercantile Exchange (NYMEX) was about $50 per barrel. A few
weeks ago, the NYMEX price reached an all-time high of just over $99
per barrel. [Exhibit 1] Although the price of oil virtually doubled
during this period--an unprecedented rise of nearly $50 in just one
year--the overall inventory of oil in the United States has been above
the 5-year average for the entire year. [Exhibit 2] It seemingly defies
the laws of supply and demand to have an astronomical increase in the
price of oil at the same time the U.S. inventory of oil has stayed
above average.
On any given day, we can read in the newspapers or hear on the
television the familiar explanations for why the price of oil is so
high. Instability in the Middle East, bad weather affecting oil
production platforms, civil strife in oil producing countries, the
declining value of the dollar. These are just a few of the ``usual
suspects'' that are often cited as the reasons for high prices.
The problem with these explanations is not that they're false. Most
of them are true. But most of them been true for some time.
Unfortunately, instability in the Middle East is not new. There is
always bad weather somewhere around the globe that affects oil
production and transportation. There is, unfortunately, a lot of civil
strife in a number of oil producing countries. The dollar rises, and
the dollar falls. The world is a dangerous place. These factors alone
cannot justify a doubling in the price of oil.
So, what else can help explain record prices? In this hearing we
will examine some of the other factors that are contributing to the
high price of oil, as well as what we can do about it.
One key factor that has contributed to the rise in oil prices over
the past few years is the virtual explosion of trading of paper
contracts for oil delivery in future months--trading which is
speculative and not intended to result in the actual delivery of oil.
Traders are trading paper oil contracts in record amounts. In the last
four years we have seen a huge increase in the number of oil futures
contracts traded on the New York Mercantile Exchange. And there also
has been tremendous growth of trading of U.S. crude oil in London. As
Secretary of Energy Bodman recently said, ``The prices for crude oil
are now set in New York and London and Tokyo, Singapore and other
trading hubs around the world.''
Data compiled by the Commodity Futures Trading Commission (CFTC)
shows that, in the past few years, out of this overall increase in
energy trading, the amount of trading due to speculation has nearly
tripled. This next chart shows that in the last few years the
percentage of oil futures contracts held by speculators has risen from
around 15% to nearly 45%. [Exhibit 14] These are traders who are solely
interested in trading for a profit, rather than hedging their positions
to assure a stable supply at a price they can count on. These energy
speculators not only comprise a larger percentage of U.S. oil trades,
but are also responsible for the larger amount of dollars involved in
U.S. energy commodity trades.
A fair price is a price that accurately reflects the forces of
supply and demand for a commodity, not the trading strategies of
speculators who only are in the market to make a profit for themselves
by the buying and selling of paper contracts with no intent to actually
purchase, deliver, or transfer the commodity. But as we have all too
often seen in recent years, when speculation grows so large that it has
a major impact on the market, prices get distorted and stop reflecting
true supply and demand.
Last year, my Subcommittee released a bipartisan report, ``The Role
of Market Speculation in Rising Oil and Gas Prices: A Need to Put the
Cop Back on the Beat.'' The report found that trading of futures
contracts by speculators had increased the demand for oil futures, and
this additional demand for contracts had contributed an additional $20
to the price of oil. At the time the price of oil was around $70 per
barrel, so speculation was a major contributor to what was then thought
to be sky-high crude oil prices. Our report recommended additional
market transparency and stronger market oversight to reduce the effects
of increased speculation.
Given the hefty increases in speculation in the U.S. oil market, we
need to know what the effect of all this speculation has been on U.S.
oil prices. To what extent, for example, has dramatically increased
speculation contributed to the extraordinary jump in prices we have
seen this year? Is speculation responsible for $20 per barrel of oil?
More? This is a vitally important question. If the extraordinary
increase in oil prices is not based on actual supply and demand, then
we need to figure out what role is being played by speculation, and
what steps can be taken to restore the market's focus on supply and
demand.
Speculation is not, of course, the only reason for sky-high oil
prices in 2007. There's another key reason we want to examine, and that
is the policy of the Administration relative to adding oil to the
Strategic Petroleum Reserve (SPR). One of today's witnesses, Dr. Philip
Verleger, will present his analysis of how the Administration's program
to fill the SPR with high-quality crude oil, also known as sweet crude,
has contributed to the recent price increases. He will tell us how the
SPR fill program has helped deplete supplies of sweet crude normally
used to fulfill crude oil futures contracts traded on the NYMEX, and
how those reduced supplies have, in turn, pushed up crude oil prices.
There's a third problem as well that the SPR fill program has
exacerbated--the fact that the standard NYMEX futures contract that
sets the benchmark price for U.S. crude oil requires a particular type
of high quality crude oil known as West Texas Intermediate (WTI) to be
delivered at a particular location, Cushing, Oklahoma. Because the
price of the standard contract depends upon the supply of WTI, which
again is but one type of sweet crude oil, the supply and demand
conditions in Oklahoma have a disproportionate influence on the price
of NYMEX futures contracts.
Four years ago, I called for reform of this outdated feature of the
standard NYMEX crude oil contract, but it has never been fixed and the
problems caused by the standard contract have gotten worse. This next
chart [Exhibit 4] shows that in 2007, the crude oil inventory in
Cushing, Oklahoma, fell. When that inventory crashed, it caused a big
supply drop in Oklahoma, even though overall U.S. crude oil inventories
remained above average. But because the Oklahoma supply fell, the
benchmark price on the NYMEX jumped, since, again, the NYMEX price
depends on the supply and demand for oil at Cushing, Oklahoma.
According to Dr. Verleger, it is only sweet crude oil that now is
in relatively short supply compared to demand, and that is part of the
reason why oil traded on the NYMEX has become so expensive. Indeed,
last month, the difference in price between sweet crude oil and some
other types of crude oils reached $20, $30, even $40 per barrel in U.S.
trading. That's a striking price gap.
Why does it matter that the Administration is depositing sweet
crude into the SPR? It matters because the price of one key type of
sweet crude, WTI, determines the price of the standard NYMEX contract.
The standard NYMEX contract price, in turn, has a major influence on
the price of fuels refined from crude oil such as gasoline, heating
oil, and diesel. That means when the WTI price is no longer
representative of the price of U.S. crude oil in general, the prices of
all of these other commodities are also thrown out of whack.
And DOE has made the situation much worse by purchasing several
million of barrels of sweet crude and depositing them into the SPR over
the past few months. Those purchases remove sweet crude from the
marketplace and reduce the supply of oil available for WTI contracts.
As you can see from the chart, the drop of several million barrels in
the inventory of crude oil at Cushing since August has been accompanied
by a huge increase in the price of U.S. crude oil. [Chart 4]. It seems
that the only place in the United States where price really reflects
supply and demand is in Cushing, Oklahoma.
In the last four months, DOE has taken several million barrels of
sweet crude off the market to fill the SPR, regardless of price. If DOE
had simply postponed the SPR fill for one year, it would have not only
alleviated the upward pressure on U.S. oil prices, but also saved U.S.
taxpayers millions of dollars. Based on the market and futures prices
at the time the DOE bought oil for the SPR, for example, DOE could have
saved $10 per barrel by simply locking in the futures price and
deferring current deliveries for one year. That's because at the time
the oil was acquired, the futures price for delivering the oil in one
year was about $10 per barrel cheaper than the current price. Since the
Administration bought enough oil to deposit another 8.7 million barrels
in the SPR, that $10 price difference would have translated into a one-
year taxpayer savings of nearly $87 million. In light of Congress's
direction in the Energy Policy Act of 2005 to fill the SPR in a manner
that minimizes costs to taxpayers and minimizes impacts on oil prices,
it is incomprehensible why DOE continues to fill the SPR without taking
advantage of the lower futures prices.
This state of affairs raises two questions. First, why is DOE
contributing to the shortage of sweet crude oil by placing it into the
SPR, and thereby helping boost the standard NYMEX price? What's worse,
it is our understanding that DOE intends to deposit another 7 million
barrels of sweet crude oil into the SPR beginning next month. DOE will
be taking this high-quality oil off the market just at the time when it
will in the highest demand to produce gasoline and diesel fuel for the
spring and summer driving seasons.
Second, it appears that we have an oil futures market that reflects
the supply and demand conditions in Oklahoma, but not necessarily the
overall supply and demand situation in the United States as a whole.
Our Subcommittee raised this very issue in 2003, and called on the CFTC
and NYMEX to work together to revise the standard NYMEX crude oil
futures contract to reduce its susceptibility to local imbalances in
the market for WTI crude oil. The Subcommittee report suggested that
allowing for delivery at other locations could reduce the volatility of
the contract. It is truly disappointing that since our report was
issued no progress has been made in allowing for delivery in other
places than Cushing. Again, the price of oil to our consumers is higher
because of that failure.
A final problem is that a large portion of trading of WTI crude oil
now takes place in London, regulated by the British authorities under
British law. How can we really know what is influencing our oil markets
when we can't see all of the market data? Although the CFTC has a data-
sharing agreement with the British authorities, none of this data is
available to the public. Unlike the U.S. oil futures market, there is
no public data on how much of the trading occurring in London is done
by speculators. So a key issue is how can we improve the transparency
of the crude oil market?
In addition to stopping the SPR fill, fixing the NYMEX contract,
and getting information about WTI trades in London, a number of us have
introduced the ``Close the Enron Loophole Act'' to improve the
transparency of U.S. energy markets Our bill would give the CFTC the
authority to police what are now unregulated electronic trading markets
for large energy traders. This vitally needed legislation is more
important right now for natural gas prices, but there is nothing
preventing crude oil contracts from being traded on unregulated
electronic markets as well, and which took place until recently. Many
of us are working together to pass this legislation as part of the Farm
Bill.
All of our witnesses today are very knowledgeable about the oil
markets. I thank all of them for their willingness to testify at this
joint hearing. I look forward to their testimony.
I would also like to express my appreciation to the Ranking Member
of the Permanent Subcommittee, Senator Coleman, and his staff, for
their support in organizing this hearing, and to our colleagues on the
Senate Energy Committee for working together with us to conduct this
joint hearing. I want to particularly thank Senators Dorgan and
Murkowski of the Subcommittee on Energy for their efforts. The price of
oil is an important issue for all of us and our constituents, as it
affects virtually every aspect of our economy. I am glad that we have
been able to work together so we can focus our witnesses and our
attention in a single forum where this issue can be examined.
Senator Levin. Senator Dorgan.
OPENING STATEMENT OF SENATOR DORGAN
Senator Dorgan. Mr. Chairman, thank you very much. We were
intending to hold a hearing in our Subcommittee this very week
with some of the same witnesses, and when we saw that you were
holding this hearing, we suggested that it be joint. I very
much appreciate your cooperation. I think this is a very
important hearing.
The Close the Enron Loophole Bill is essential. I chaired
the hearings in the Commerce Committee where Ken Lay came and
took the Fifth Amendment. I chaired a good number of hearings
on Enron in that Commerce Subcommittee and know a fair amount
about what happened back then. No one is suggesting there is an
equivalent set of actions here. We now know that what happened
with respect to the Enron loophole is that markets were
manipulated. Billions of dollars were extracted from the
pockets of the victims, that is the consumers, particularly on
the West Coast. We know that it was criminal activity and a
criminal enterprise now. But we know that much of that was able
to take place outside of the view of regulators.
This question of the price of oil on the futures market
raises the same sort of issues, and long past the time when we
discovered Enron was a criminal enterprise, we have not yet
closed the Enron loophole that allowed all that activity to
take place outside of the view of regulators. I am proud to be
a cosponsor, Mr. Chairman, of that legislation.
There is not a free market in oil. With the substantial
blockbuster mergers in the oil industry, the companies have
more power and more muscle in the marketplace. The OPEC nations
control 40 percent of the world's oil supply, including the
faucet that feeds much of our oil addiction. Ninety percent of
the oil is controlled by companies that are at least partially
or wholly state-owned, and, of course, that moves them away
from some of the market principles. And finally, the
commodities futures market, in my judgment, has become an orgy
of financial speculation, a carnival of greed almost, and I
believe it is substantially increasing the market price for a
barrel of oil.
I used to teach a little economics, and some might hear
that statement and say, well, it must have been very little,
but I will say this. There are some, I think, thoughtful
economists who take a look at what is happening in the futures
market and say that this has become an unbelievable amount of
speculative activity that is driving up the price of oil,
having very little to do with supply and demand.
There is so much money sloshing around in these markets
these days. Hedge funds are up hip deep into these markets.
Investment banks are also into these markets. I don't know
because I haven't investigated it, but I have read
investigative reports that investment banks in some cases are
even constructing storage facilities in order to store oil,
keep it off the market, anticipating the market price will
increase. That means you reduce supply, and as you reduce
supply, drive up price and hold oil for profits later. These
are people that don't want to buy any oil. They don't want to
ever own any oil except on paper, but they want to be in the
futures market to be speculators and make a lot of money.
Now, Mr. Chairman, if I might show Exhibit No. 18 \1\
first, your Subcommittee did some extraordinary work in
detailing the Amaranth issue. A 32-year-old energy trader
helped to lead to the collapse of an $8 billion hedge fund.
This is in natural gas. You all did this. It was interesting to
me, why is it that you were able to dig this out and the
referees, the people that are supposed to wear the striped
shirts, the people that are paid on the public payroll, didn't
know this. Why is it that the regulators couldn't see this? It
is because we have a system in which they are prevented from
knowing what happens on the unregulated exchanges.
---------------------------------------------------------------------------
\1\ See Exhibit No. 18, which appears in the Appendix on page 205.
---------------------------------------------------------------------------
And so if I might see Exhibit No. 16,\1\ after I read about
Amaranth and the work that you had done on this Subcommittee,
which seems to me to just be ``case closed'' in terms of should
we do something, CNNMoney.com had this on it. It said, ``It has
been rumored that Goldman Sachs has over $80 billion in the
market. Its influence is so big traders refer to the day of the
month when the bank sells the current month contract and buys
the future month as the `Goldman roll' due to its effect on
price.'' Once again, the notion of big investment banks being
involved in this speculative market.
---------------------------------------------------------------------------
\1\ See Exhibit No. 16, which appears in the Appendix on page 203.
---------------------------------------------------------------------------
That is a change. That is new. And it dramatically affects
the market in a way that is not related to ordinary supply and
demand relationships. So something is wrong.
I support the marketplace. I think it is a wonderful thing.
When it works well, it is the best allocator of goods and
service. And you must have a futures market for liquidity and
so on. But it seems to me that the case has been made that we
have a circumstance now where there is no shortage of oil. We
can make a case that, yes, China is going to have 100 million
additional cars on the road in 15 years and has demand. You can
make lots of cases that we are going to be short of oil in the
future. I understand that.
But look at the fundamentals now and evaluate. Are we short
of oil? What would cause these prices to move up and bob around
at $90 and $100 a barrel? The cause, in my judgment, is
unbelievable speculation and unregulated over-the-counter
markets that leaves this country and the markets open to market
manipulation of oil prices.
We need to give the CFTC the broader ability to prevent
fraud, manipulation, excessive speculation in these commodity
markets, and a good start in doing that is the Close the Enron
Loophole bill. If there is a legal loophole that can be
exploited, our experience having served in Congress and
watching this is it will be exploited. When we see it being
exploited, we have a responsibility to change it.
If price increases in oil are due to supply and demand
imbalances, then economic policies can be developed to
encourage investments in new energy sources and conservation.
If price increases are due to geopolitical factors in producer
countries, then you develop foreign policies to try to respond
to that. If price increases are due to hurricane damage that
damage investments, then you can develop other kinds of
approaches in Congress to respond to that. But to the extent
that energy prices are the result of excessive speculation,
only a cop on the beat, only an effective regulator with the
tools to regulate, with both oversight and enforcement
authority, is going to solve this problem.
So, Mr. Chairman, I thank you. I am pleased to join you.
And once again, I see no justification in the marketplace for
oil prices to reach $100 a barrel. I think there is a carnival
of speculation out there that is unhealthy for this country and
this Congress has a responsibility to give regulators the tools
they need.
Senator Levin. Thank you so much, Senator Dorgan. Senator
Coleman.
OPENING STATEMENT OF SENATOR COLEMAN
Senator Coleman. Thank you, Mr. Chairman. Over the past 5
years, the Permanent Subcommittee on Investigations has
conducted a number of investigations into volatility and price
increases in essential U.S. energy commodities, including
natural gas, gasoline, and crude oil. These investigations have
examined not only the role of market speculation in rising
energy prices, but also the adequacy of government oversight in
the markets that set these prices.
Today's hearing, which focuses on the impact of market
speculation on crude oil prices, continues the Subcommittee's
bipartisan effort to ensure the integrity of U.S. energy
prices. As always, I would like to thank Chairman Levin and his
staff for their hard work on these issues.
Americans are upset because they are paying more for oil
than ever before, and a lot of people are concerned that
speculation is behind the record price surge. Today's hearing
is an important step in addressing these concerns and an
important reminder that high energy prices affect all
Americans.
Over the past several years, U.S. oil and gas markets have
experienced unprecedented volatility and significant price
increases. Since 2000, the price of crude oil has jumped from a
range of $25 to $30 per barrel to over $90 per barrel. And
since last year alone, crude oil prices have increased by $20
to $30 per barrel, often approaching a staggering $100 per
barrel.
Record high crude oil prices have affected everything from
home heating bills to holiday travel, and American families and
small businesses are feeling the squeeze. Today, the cost of
gasoline at the pump hovers around $3 a gallon. Diesel fuel,
which is often used by trucking companies and delivery
services, remains even higher. And of particular concern back
home in Minnesota, the cost of heating oil continues to rise.
As a Senator from the Midwest, I know all too well that
heating bills will place millions of Americans in financial
jeopardy this winter. I will never forget the testimony I heard
during the Subcommittee's field hearing in St. Paul last year.
Too many Americans find themselves in similar circumstances to
Deidre Jackson and Lucille Olsen, who testified about the
burdens caused by rising energy costs. In the case of Ms.
Olsen, her home heating bill represented 30 percent of her
monthly income. As a senior citizen trying to cope with the
high cost of health insurance and prescription drugs, last
year's spikes in energy prices made it difficult for her to
make ends meet. Ms. Jackson, a working mother of three and a
college student, shared with me the financial jeopardy she
faced as a result of a home heating bill that increased by more
than 100 percent.
As crude oil prices have soared to record levels, Ms.
Jackson's and Ms. Olsen's testimony provided powerful reminders
of the real world impacts of high energy prices. In the short
term, this situation means there is a lot of hardship for a lot
of folks who can't afford double-digit heating increases, and I
have got to tell you, in Minnesota, where I have already been
shoveling snow--it was minus-9 in St. Paul not too long ago,
and I think minus-27 in Northern Minnesota--there is going to
be a great impact. So it is important that Congress consider
the factors that have contributed to the record price run-up.
The Department of Energy has announced larger than expected
stockpiles of both crude oil and gasoline, and most experts
agree that there is no overall shortage of U.S. crude.
Nevertheless, oil prices remain at near record highs,
suggesting that forces other than supply and demand may have
contributed to these increases.
People are concerned that speculative trading is the reason
for the unprecedented price surge for crude oil. We have called
today's hearing to specifically address these concerns.
A number of Subcommittee investigations have focused on the
troubling level of high-risk speculative trading that occurs on
U.S. energy markets, much of it on unregulated over-the-counter
energy exchanges exempted from government oversight. Financial
institutions, pension funds, hedge funds, and other speculative
investors have deployed tens of billions of dollars in
speculative capital to U.S. crude oil markets. These traders
bring important liquidity and vitality to our energy markets,
but they should not be allowed to overwhelm the real buyers and
sellers of crude oil, including utilities and industrial users.
For this reason, it is imperative that Congress provide
regulators with the statutory authority and budget necessary to
police our energy markets and ensure the integrity of our
energy prices.
That said, it is still hard to pin the run-up on crude oil
on speculation run amok. The markets still appear to respond to
supply and demand fundamentals. Last year, as Chairman Levin
noted, our report highlighted the impact of speculation on the
price of oil and gas. Again, though, as we look at it in terms
of responding to fundamentals, it appears that the long-term
underlying trend for crude oil is that demand is increasing
while supply remains tight. Geopolitical instability, including
uncertain situations in Iraq and Iran, have created fears of
potential supply disruption and a substantial risk premium has
been built into current prices.
Beyond those temporary concerns, global demand for crude
oil fueled by China and India's development continues to
increase, leaving many investors worried that global supplies
cannot keep pace with demand. Add to these concerns the fact
that our refining capacity cannot satisfy projected demand, and
it becomes clear that there is more behind high crude oil
prices than just market speculation.
Oil prices are at record highs because the United States
and the rest of the world are consuming oil at unprecedented
levels. It is a matter of when, not if, global supplies will be
unable to meet our demand. And we here in Congress cannot
forget that we are part of the problem.
The Chairman noted and went through with great detail the
impact on cost of putting sweet crude oil into the strategic
reserve. I intend to question the witnesses about this. There
are concerns about whether there are environmental regulations
that impact this. But clearly, that is from a micro perspective
part of the problem.
We also have to look at the macro. We have not taken the
necessary steps to reduce our dependence on foreign oil. More
than ever before, it is imperative that we explore alternative
sources of energy. At the same time, the U.S. Congress must
work to ensure the integrity of U.S. energy markets by
providing regulators, as I said before, with the statutory
authority and resources necessary to do their job. As we do so,
we must protect competition and avoid unintended consequences,
namely creating incentives for investors to move to less-
transparent energy markets, including those offshore.
Just one last comment on this, kind of the macro issue. As
we deal with the cost of oil today, one of the things that I
can't forget is that in the early 1970s, this country went
through a run-up in the cost of gasoline, went through long
lines, and for a moment it appeared that we would do something
about it. Brazil went through the same thing. In 1970, they
embarked on a course of ending their country's dependence on
foreign oil and what happened is despite then the rises and
falls in the price of gas and a barrel of oil, Brazil stayed on
course and today is in a situation where they don't have to
import foreign oil. It is hard to buy a car in Brazil that is
not a flex-fuel engine.
In this country, unfortunately, as prices dropped, it
pulled the market out of a lot of alternative sources of
energy, and 30 years later, we find ourselves still kind of at
the starting gate. I think whatever we do here, that we have to
take a long-term perspective and understand that we have to end
dependence on foreign oil.
So I hope as we address the situation this winter, that we
are looking five, ten winters ahead so that the generation
after me doesn't come up to the plate and find themselves in
the same situation.
Again, I would like to thank Chairman Levin for initiating
today's bipartisan hearing. I would like to thank today's
witnesses for their testimony on these important issues. Thank
you, Mr. Chairman.
[The prepared statement of Senator Coleman follows:]
OPENING STATEMENT OF SENATOR NORM COLEMAN
Over the past five years, the Permanent Subcommittee on
Investigations has conducted a number of investigations into volatility
and price increases in essential U.S. energy commodities, including
natural gas, gasoline, and crude oil. These investigations have
examined not only the role of market speculation in rising energy
prices, but also the adequacy of government oversight in the markets
that set these prices. Today's hearing, which focuses on the impact of
market speculation on crude oil prices, continues the Subcommittee's
bipartisan effort to ensure the integrity of U.S. energy prices. As
always, I would like to thank Chairman Levin and his staff for their
hard work on these issues. Americans are upset that they are paying
more for oil than ever before, and a lot of people are concerned that
speculation is behind the record price surge. Today's hearing is an
important step in addressing these concerns and an important reminder
that high energy prices affect all Americans.
Over the past several years, U.S. oil and gas markets have
experienced unprecedented volatility and significant price increases.
Since 2000, the price of crude oil has jumped from a range of $25-$30
per barrel to over $90 per barrel. In the last year alone, crude oil
prices have increased by a $20-$30 per barrel, often approaching a
staggering $100 per barrel.
Record high crude oil prices have affected everything from home
heating bills to holiday travel, and American families and small
businesses are feeling the squeeze. Today, the cost of gasoline at the
pump hovers around $3 a gallon. Diesel fuel, which is often used by
trucking companies and delivery services, remains even higher. And of
particular concern back home in Minnesota, the cost of heating oil
continues to rise.
As a Senator from the Midwest, I know all to well that heating
bills will place millions of Americans in financial jeopardy this
winter. I will never forget the testimony I heard during the
Subcommittee's field hearing in St. Paul last year. Too many Americans
find themselves in circumstances similar to Deidre Jackson and Lucille
Olson, who testified about the burdens caused by rising energy costs.
In the case of Ms. Olson, her home heating bill represented 30 percent
of her monthly income. As a senior citizen trying to cope with the high
costs of health insurance and prescription drugs, last year's spikes in
energy prices made it difficult for her to make ends meet. Ms. Jackson,
a working mother of three and a college student, shared with me the
financial jeopardy she faced as a result of a home heating bill that
had increased by more than 100 percent. As crude oil prices soar to
record levels, Ms. Jackson's and Ms Olson's testimony provided powerful
reminders of the real-world impacts of high energy prices.
In the short-term, this situation means there is a lot of hardship
for a lot of folks who can't afford double-digit heating cost
increases. It is critical that Congress examine the factors that have
contributed to the record price run-up. The Department of Energy has
announced larger-than-expected stockpiles of both crude oil and
gasoline, and most experts agree that there is no overall shortage of
U.S. crude. Nevertheless, oil prices remain at near record highs,
suggesting that forces other than supply and demand may have
contributed to these increases.
People are concerned that speculative trading is the reason for the
unprecedented price surge for crude oil. We have called today's hearing
to specifically address these concerns. A number of Subcommittee
investigations have focused on the troubling level of high-risk,
speculative trading that occurs on U.S. energy markets--much of it on
unregulated, over-the-counter energy exchanges, exempted from
government oversight. Financial institutions, pension funds, hedge
funds, and other speculative investors have deployed tens of billions
of dollars in speculative capital to U.S. crude oil markets. These
traders bring important liquidity and vitality to our energy markets,
but they should not be allowed to overwhelm the real buyers and sellers
of crude oil, including utilities and industrial users. For this
reason, it is imperative that Congress provide regulators with the
statutory authority and budget necessary to police our energy markets
and ensure the integrity of our energy prices.
That said, it is still hard to pin the price run-up for crude oil
on speculation run amuck. The markets still appear to be responding to
supply and demand fundamentals. The long-term underlying trend for
crude oil is that demand is increasing while supply remains tight.
Geopolitical instability, including uncertain situations in Iraq and
Iran, has created fears of potential supply disruptions, and a
substantial ``risk premium'' has been built into current prices. Beyond
those temporary concerns, global demand for crude oil, fueled by China
and India's development, continues to increase, leaving many investors
worried that global supplies cannot keep pace with demand. Add to these
concerns the fact that our refining capacity cannot satisfy our
projected demand and it becomes clear that more is behind high crude
oil prices than market speculation.
Oil prices are at record highs because the U.S. and the rest of the
world are consuming oil at unprecedented levels. It is a matter of
when, not if, that global supplies will be unable to meet our demand.
And we here in Congress cannot forget that we are part of the problem.
We have not taken the necessary steps to reduce our dependence on
foreign oil. More than ever before, it is imperative that we explore
alternative sources of energy. Moreover, Congress must work to ensure
the integrity of U.S. energy markets by providing regulators with the
statutory authority and resources necessary to do their jobs. As we do
so, however, we must protect competition and avoid unintended
consequences--namely, creating incentives for investors to move to less
transparent energy markets, including those offshore.
Again, I would like to thank Chairman Levin for initiating today's
bipartisan hearing. I would like to thank today's witnesses for their
testimony on these important issues.
Senator Levin. Thank you so much, Senator Coleman. Senator
Murkowski.
OPENING STATEMENT OF SENATOR MURKOWSKI
Senator Murkowski. Thank you, Mr. Chairman, and thank you
to the panel here before us this morning. I appreciate your
being here. I do believe that your testimony this morning will
be very helpful to us as we seek to determine whether
increasing demand, market speculation, or a combination of
those and other factors have led us to where we are today, with
the price of crude oil approaching really an all-time high.
In looking at how oil is traded, it is also important to
focus on the basic fundamentals of the market. In the global
market, the price of oil is set by supply and demand
conditions. Economics 101 teaches us that when demand is high
and supply is low, the market will see an increase in price.
So, therefore, even as we examine the possible role that
speculation has played in the increase of crude oil prices, we
must not lose sight of the fact that high oil prices are being
driven by a lot of different factors out there. These include
the increases in global oil demand, reduced supply, ongoing
geopolitical concerns, and decreased refinery capacity. We all
know that oil demand in China, for example, appears to be
continuing its recent double-digit advances.
Since the beginning of this year, oil prices have increased
by nearly 40 percent, and while this is very steep, it is not
unprecedented. Over the past 10 years, crude oil prices have
increased by approximately 370 percent. Much of this increase
occurred in the absence of heavy trading and is broadly
attributed to the increase in global demand.
According to the EIA, global demand for oil is projected to
rise by 1.1 million barrels per day in 2007 and 1.5 million
barrels per day in 2008. Total U.S. petroleum consumption is
expected to increase by 0.5 percent in 2007 and 1 percent in
2008. This increase, which has brought the demand levels much
closer to supply levels, can be connected to the economic
growth of the United States and to colder winter temperatures,
which will continue to boost the demand for our heating oil.
So with the high prices and the growing consumption, we
have got to figure out ways that we can increase our domestic
production. Currently, the OPEC countries continue to be the
largest oil producing countries and hold the largest percent of
oil reserves. Seventy-seven percent of the world's oil reserves
are located outside of the United States. Since November 2007,
OPEC's production has decreased by 1.2 million barrels per day,
partially the result of political instability in Nigeria,
Venezuela, and Iran. We know that events in these countries
have directly contributed to and quite honestly become a
constant factor in higher crude oil prices.
Also related to the topic of increasing supply is the need
to increase our ability to refine the supply and to diversify
the places where refining takes place. EIA has reported that
the current domestic refinery capacity expansion plan estimates
approximately one million barrels per day by 2012. This is the
equivalent of five new refineries. Our domestic refining
capacity is growing, but not as quickly as we would hope that
it would.
So we need to find ways to increase capacity at existing
refineries more quickly, and we also need to explore and
promote ways to build new refineries in places outside of the
Gulf of Mexico. We look back to Hurricane Katrina and certainly
realize that that made us painfully aware that the lack of
refining capacity in this country must be addressed. We have
got to ensure that new refineries are built. If we don't
address the need for more refinery capacity in the United
States, our dependence on our imports for petroleum products
will continue to increase, our record trade deficit will grow
even larger as we have to import more finished products, and
the number of skilled jobs lost from the construction,
operation, and maintenance of domestic refineries will
increase.
So in spite of the increase in oil and petroleum costs,
global oil markets will likely remain tight as world oil
demands continue to grow. The best way to continue to address
this issue is to increase domestic production, promote
alternative fuels, and conserve greater amounts of energy, no
great revelation there. Certainly as an Alaska Senator, I would
be remiss if I didn't take an opportunity to urge that in this
Nation as we look to increased domestic production that we look
to the Arctic Coastal Plain. We also need to increase
development in the Outer Continental Shelf and to increase oil
shale production in the West.
I do appreciate the significance, the timing of this
hearing this morning, the willingness to hold the hearing to
examine crude oil speculation in greater detail, but I also
view this as an opportunity to recognize that while speculation
may contribute to high oil prices, it is just one piece in a
much larger puzzle.
So again, Mr. Chairman, I appreciate you convening this
joint hearing this morning and look forward to the testimony
from all. Thank you.
[The prepared statement of Senator Murkowski follows:]
OPENING STATEMENT OF SENATOR LISA MURKOWSKI
Welcome. I want to thank our panel of witnesses for taking time out
of their busy schedules to join us today. Your testimony will be
invaluable as we seek to determine whether increasing demand, market
speculation, or a combination of those and other factors have led the
price of crude oil to approach its all-time high.
As oil prices approached the $100 per barrel mark, the media began
to draw attention to financial energy market activity. Market analysts
began to question whether supply and demand, coupled with geopolitical
instability and a number of short-term incidents, were enough to drive
crude prices as high as they are.
This prompted those of us in Congress, private industry, and
consumers to begin a similar debate, and to seek answers about the
effects that energy trading has on the price of crude oil and its
supply. Some have now concluded that energy prices are pushed and
sustained at high levels because of speculation, and that the large
privately owned oil companies and financial banks are manipulating the
market.
Oil is the world's most actively traded global commodity, and there
are several different ways it can be traded. For example, oil can be
traded on the ``spot'' market, which involves transactions for
immediate or short-term delivery of oil at a specific site. Oil can
also be traded through futures contracts, which are agreements to
purchase or sell a given amount of crude oil at a price determined when
the agreement is reached.
Futures contracts can be traded in two venues: 1) on the New York
Mercantile Exchange (NYMEX) which is traded in units of 1,000 barrels
of oil to be delivered at Cushing, Oklahoma, and 2) off the exchange in
over-the-counter (OTC) transactions, which often occur through voice-
brokers or online market platforms. Traders in each of these markets
must follow certain guidelines, although the level of regulatory
scrutiny that applies depends on the market in which the oil is traded
in.
The requirements for future energy contracts are laid out in the
Commodity Exchange Act (CEA), last amended in 2000 with passage of the
Commodity Futures Modernization Act. These requirements include record-
keeping and reporting, market surveillance, curbs on excessive
speculation, and the establishment of various financial standards. And
even though OTC contracts are traded without Commodity Futures Trading
Commission oversight under current law, they are still subject to the
CEA antifraud and anti-manipulations provisions.
In looking at how oil is traded, it is also important to focus on
the fundamental basics of the market. In the global market, the price
of oil is set by supply and demand conditions. Economics 101 teaches us
that when demand is high and supply is low, the market will see an
increase in price; when supply outpaces demand, the price of the
commodity will decrease. Therefore, even as we examine the possible
role speculation has played in the increase of crude oil prices, we
must not lose sight that high oil prices are being driven by many
factors. These include increases in global oil demand, reduced supply,
ongoing geo-political concerns, and decreased refinery capacity.
Since the beginning of this year, oil prices have increased by
nearly 40 percent. While steep, this is not unprecedented--over the
past 10 years, crude oil prices have increased by approximately 370
percent. Much of this increase occurred in the absence of heavy trading
and is broadly attributed to the increase in global demand. According
to the Energy Information Administration, or EIA, global demand for oil
is projected to rise by 1.1 million barrels per day in 2007 and 1.5
million barrels per day in 2008. Total U.S. petroleum consumption is
expected to increase by 0.5% in 2007 and 1.0% in 2008. This increase,
which has brought demand levels much closer to supply levels, can be
connected to the economic growth of the U.S. and to colder winter
temperatures, which will continue to boost demand for heating oil.
With high prices and growing consumption, we need to find ways to
increase our domestic production. Even though U.S. oil production is
projected to average 5.1 million barrels per day in 2007, which is an
increase of 0.3% from 2006 production levels, this is just a portion of
the supply needed to meet the demand. And unfortunately this country
still relies heavily on foreign oil imports and so the Organization of
the Petroleum Exporting Countries (OPEC) needs to increase supply
production to fill in the gap.
Currently, OPEC countries continue to be the largest oil producing
countries and hold the largest percent of oil reserves. 77% of the
world's oil reserves are located outside of the U.S., with a large
portion held by national or state-owned oil companies. These reserves
are considerably larger than the reserves owned by ExxonMobil, the
largest multinational oil company. Yet, since November 2006, OPEC has
decreased production by 1.2 million barrels per day, partially because
of political instability in Nigeria, Venezuela, and Iran. Events in
these countries have directly contributed to, and become a constant
factor in, higher crude oil prices.
Related to the topic of increasing supply is the need to increase
our ability to refine the supply, and to diversify the places where
refining takes place. EIA reports that current domestic refinery
capacity expansion plan estimates are approximately 1 million barrels
per day by 2012, equivalent to five new refineries. But this figure is
one-third lower than EIA's estimate in 2006, which projected refinery
capacity of 1.5 million barrels per day in 2012. So domestic refining
capacity is declining, but demand is still increasing.
We need to find ways to increase capacity at existing refineries.
We need to explore, and promote, ways to build new refineries in places
outside the Gulf of Mexico. Less capacity will not restrain demand--it
will restrict supply, and ultimately increase prices at the pump. When
supply and demand are tight, there is also little flexibility to
accommodate unplanned refinery outages, which could have dangerous
consequences.
Hurricane Katrina made it painfully clear that the lack of refining
capacity in this country must be addressed. Almost 50% of the U.S.
refinery capacity is located in the Gulf Coast. Hurricane Katrina shut
down 10% of U.S. refinery capacity. We did not have spare space at
other refineries to absorb that shock. Over the past several years,
refineries have been consistently running close to 90 percent capacity
utilization, compared to 78 percent utilization in 1985.
We need to ensure that new refineries are built. If we do not
address the need for more refinery capacity in the United States:
<bullet> our dependence on imports for petroleum products will
continue to increase,
<bullet> our record trade deficit will grow even larger as we have
to import more finished products, and
<bullet> the number of skilled jobs lost from the construction,
operation and maintenance of domestic refineries will increase,
depriving hardworking Americans of a chance to earn a good living.
In spite of the increase in oil and petroleum costs, global oil
markets will likely remain tight as world oil demands continue to grow.
The best way to address this continuing issue is to increase domestic
production, promote alternative fuels, and conserve greater amounts of
energy.
As an Alaska Senator I would like to see development occur on shore
from the Arctic coastal plain in Alaska. We also need to increase
development in the outer continental shelf and to increase oil shale
production in the West.
Mr. Chairmen, I appreciate your willingness to hold this hearing
and examine crude oil speculation in greater detail. But this is also
an opportunity to recognize that while speculation may contribute
something to high oil prices, it is just one piece of a much larger
puzzle. Those of us in Congress have a responsibility to ensure
affordable energy for all Americans, but we will not succeed in this
effort until we examine and address every factor which could be behind
high prices. I look forward to hearing from today's witnesses, and,
going forward, to working with the members of these Subcommittees to
resolve this serious matter.
Senator Levin. Thank you, Senator Murkowski.
Let me now call upon the Ranking Member of the Homeland
Security Committee, Senator Collins, and then we will call on
the other Senators who are here in the order of their
appearance for their opening statements, if they have any.
Senator Collins.
OPENING STATEMENT OF SENATOR COLLINS
Senator Collins. Thank you. Thank you, Mr. Chairman. Long
before the first official day of winter, the people of my State
of Maine have been coping with cold weather and feeling the
strain of high prices for home heating oil, gasoline, diesel
fuel, and other products refined from fuel. According to the
Energy Information Administration, last month, the benchmark
price for a barrel of domestic crude oil averaged nearly $95.
Compare that to $59 for November a year ago and you see a
startling increase in a single year.
That remarkable rise touches virtually every aspect of our
economy. Oil prices significantly affect the costs of heating
homes, driving family cars and commercial trucks, running
fishing boats, operating farm and logging equipment, flying
airplanes, making fertilizers, manufacturing plastics--the list
goes on and on.
Many causes contribute to the sharp rise in oil prices:
Increased global demand for crude oil, instability in the
Middle East and Venezuela, supply decisions of the OPEC cartel,
insufficient U.S. refining capacity, the declining value of the
dollar, and speculative trading on future markets.
I would note that Chairman Levin and I joined forces a few
years ago on a bipartisan amendment directing the Department of
Energy to better manage the Strategic Petroleum Reserve. We
worked on legislation, which I was proud to be the cosponsor of
Senator Levin's proposal, that the DOE should suspend purchases
when prices were high so as not to further drive up prices by
taking oil off the market. Now I question whether the intent of
our amendment has been realized in the implementation by the
Department of Energy.
Our paramount challenge, of course, is to reduce our over-
reliance on imported oil. That dependence threatens our
economic and national security. We need to pursue the long-term
goal of energy independence just as fervently as the Nation
embraced President Kennedy's goal in 1961 of putting a man on
the moon.
In the meantime, however, we must increase funding for the
Low-Income Heating Assistance Program and take other actions to
ease the current impact of high prices. For example, Congress
should pass carefully crafted legislation to help curb
speculation on futures markets that can artificially drive up
energy prices beyond what normal supply and demand
considerations would produce.
As has been mentioned this morning by Senator Levin and
Senator Coleman, an investigation by the Permanent Subcommittee
concluded that speculators can create additional demand for
oil, driving up the price even when they seldom deliver or
receive any oil themselves. I have heard recently from the
Maine Oil Dealers Association and from commercial truckers in
Maine who firmly believe that speculation has been a factor in
the most recent oil price increases that are hurting their
businesses and their customers.
Unfortunately, there is a lack of publicly available data
to track the effect of speculation on market prices and
manipulation can go undetected on certain unregulated markets,
and that is why I support expanding the authority of the
Federal Government to oversee energy futures markets and to
provide greater transparency, which I think is the best
safeguard against manipulation.
I recognize that such legislation must be carefully
crafted, however. The ability to have contracts keyed to future
prices can provide significant benefits. Legislation is needed,
but it must be carefully targeted so as not to damage
legitimate risk hedging functions.
Well-functioning markets obviously benefit consumers by
promoting price competition, by encouraging the development of
new products and by attracting capital for new enterprises. But
it is also a fact that when the government and the public have
little information about trades on unregulated or lightly-
regulated markets, real abuses can occur. Unsupervised markets
are open to deceptive practices and active or passive
collusion. Government has a vital role to play in ensuring that
markets are transparent and competitive, and regulators must
have the information and authority that they need to limit
excesses that can cause disruptive price swings or artificial
increases in price levels.
This hearing will help us better identify and quantify the
role of excessive speculation in the level and volatility of
oil prices. It will also help us identify exactly what steps we
should take to ensure that Federal regulators have the right
tools to guard against manipulation and other abuses.
I want to commend both the Chairmen and the Ranking Members
for their leadership in pursuing these issues and I look
forward to the testimony of our expert witnesses. Thank you,
Senator Levin.
[The prepared statement of Senator Collins follows:]
OPENING STATEMENT OF SENATOR SUSAN M. COLLINS
Long before the first official day of winter, the people of Maine
have been coping with cold weather and feeling the strain of high
prices for home heating oil, gasoline, diesel fuel, and other products
refined from oil.
According to the Energy Information Administration, last month the
benchmark price for a barrel of domestic crude oil averaged nearly $95.
Compare that to $59 for November a year ago, and you see a 60 percent
increase in a single year.
That remarkable rise touches virtually every aspect of the economy.
Oil prices significantly affect the costs of heating homes, driving
family cars and commercial trucks, running fishing boats, operating
farm and logging equipment, flying airplanes, making fertilizers,
manufacturing plastics, and so on.
Many causes contribute to the sharp rise in oil prices: increased
global demand for crude oil, instability in the Middle East and
Venezuela, supply decisions of the OPEC cartel, insufficient U.S.
refining capacity, the declining value of the dollar, and speculative
trading on futures markets.
I would also note that Chairman Levin and I joined forces a few
years ago on a bipartisan amendment to the 2005 energy bill directing
the Department of Energy to better manage the Strategic Petroleum
Reserve by suspending purchases when prices were high so as not to
drive up prices further by taking oil off the market. There are
questions, however, about whether the Administration has implemented
this program effectively.
Our paramount challenge, of course, is to reduce our over-reliance
on imported oil. That dependence threatens our economic and national
security. We need to pursue the long-term goal of energy independence
just as fervently as the nation embraced President Kennedy's goal in
1961 of putting a man on the moon.
In the meantime, however, we must increase funding for the Low
Income Heating Assistance Program and take other actions to ease the
current impact of high prices. For example, Congress should pass
carefully crafted legislation to help curb speculation on futures
markets that can artificially drive up energy prices beyond what normal
supply-and-demand considerations would produce.
In 2005, an investigation by this Subcommittee concluded that
speculators can create additional demand for oil, driving up the price
even though they seldom deliver or receive any oil themselves. I have
heard recently from the Maine Oil Dealers Association and from
commercial truckers in Maine who firmly believe that speculation has
been a factor in the oil-price increases that are hurting their
businesses and their customers.
Unfortunately, there is a lack of publicly available data to track
the effect of speculation on market prices, and manipulation can go
undetected on certain unregulated markets. That is why I support
expanding the authority of the federal government to oversee energy
futures markets and to provide greater transparency to guard against
manipulation.
Such legislation must be carefully crafted, however. The ability to
make contracts keyed to future prices can provide significant benefits,
such as allowing heating-oil dealers and other businesses to hedge
their risk exposure to future price changes. Legislation is needed but
should be carefully targeted so as not to damage legitimate risk-
hedging functions.
Well-functioning markets benefit consumers by promoting price
competition, by encouraging development of new products, and by
attracting capital for new enterprises.
But it is also a fact that when government and the public have
little information about trades on unregulated or lightly regulated
markets, real abuses can occur.
Unsupervised markets are open to deceptive practices and active or
passive collusion. Government has a vital role to play in ensuring that
markets are transparent and competitive. Regulators must have the
information and authority to monitor trading and to limit excesses that
can cause disruptive price swings or artificial increases in price
levels.
This hearing will help us identify and quantify the role of
excessive speculation in the level and volatility of oil prices, and
highlight the steps we must take to ensure that federal regulators have
the right tools to guard against manipulation and other abuses.
I commend the Chairman and the Ranking Member for their leadership
in pursuing these issues and look forward to the testimony of our
expert witnesses.
Senator Levin. Thank you, Senator Collins. Senator Wyden.
OPENING STATEMENT OF SENATOR WYDEN
Senator Wyden. Thank you, Mr. Chairman, and I, too, want to
join colleagues in commending you and the bipartisan leadership
of both of these Committees.
I have been digging into this issue, as well, for a number
of years. What really triggered it was 2 years ago--I think
Senator Cantwell was there, as well--Lee Raymond, who was then
the head of Exxon Mobil, came before the Energy Committee and I
asked him about speculation in the oil market. And Mr. Raymond,
obviously one of the most knowledgeable people in the oil
business, said that he believed that speculation in the oil
markets was adding $20 a barrel to the price of oil when oil
was then $55 a barrel. I note we have experts at the table. Mr.
Gheit has been quoted in the paper, obviously one of the most
knowledgeable people in the business, saying that speculation
is adding as much as $30 to the price of a barrel of oil.
So given what we came to learn from these experts, I began
to look at the landscape with respect to speculation generally,
and I think that Chairman Levin, Senator Coleman, and others
described how complicated this is. And it is quite clear that
there are a variety of different ways in which the speculators
engage in their various activities.
Some do it on the financial side, which is primarily what
we have been talking about today, efforts that come under the
jurisdiction of the Commodity Futures Trading Commission,
agencies charged with overseeing the financial side. Some, and
I am very concerned about this now and will touch on it in just
a second, are simply buying oil and holding it. The effort to
oversee this has been pretty much non-existent, which gets me
to Mr. Caruso, I have always thought is a very good guy, but I
think this agency really has its head in the sand with respect
to the extent of this problem.
I want to read into the record now, Mr. Chairman, just a
couple of comments from this agency, which is the lead agency,
the lead Federal agency for analyzing information about prices
and supply. They say, for example, in August 2006, ``available
evidence suggests that increased speculative activity in the
oil markets is a symptom of rather than a cause of high oil
prices.'' In their analysis in November 2007, they pretty much
dismiss the whole issue because they say ``it is difficult to
assess.''
Now, there is no question about that, because the markets
are tight. Certainly they are volatile. These are all
conditions where you would naturally have speculators try to
take advantage of those factors, but that is all the more
reason why the lead Federal agency in this area ought to get
off the sidelines, abandon this ``see no evil, hear no evil,
speak no evil'' approach, and get into the business of
analyzing this information.
I will close, Mr. Chairman, by saying I am particularly
interested in how they have responded to this question of those
who are holding oil in the physical market. There is no doubt,
and some of our witnesses are going to talk about this today,
that there are a number of commodities speculators that are
buying and holding oil, literally barrels of oil sitting in
storage. Now, despite record prices for the purchase of each of
these barrels, inventories have been above average because they
obviously believe they can make good money when the price goes
higher.
The Energy Information Agency reports inventory levels.
When they were before the Energy Committee earlier, I asked
that they report what data they had on who was holding the oil.
The answer is they don't know because they don't collect the
information. So they really don't have good data. And that is
what they are supposed to be in the business of, on one of the
key issues that I think the American people have a right to
know as we dig into this speculation issue. I think they ought
to be in the position of really looking at what is going on,
collecting the sort of large trader information on, for
example, physical energy inventory, and we get to the bottom of
this. And we continue the work that you, Mr. Chairman, and our
colleagues on a bipartisan basis are pursuing.
I thank you.
Senator Levin. Thank you, Senator Wyden.
On an early bird basis, let me see if the following
Senators have opening statements. Senator Corker.
Senator Corker. I would just as soon hear the testimony.
Senator Levin. Thank you very much. Senator Craig would be
next.
OPENING STATEMENT OF SENATOR CRAIG
Senator Craig. Mr. Chairman, let me thank all of you for
this hearing. Critical to the American consumer is the price of
their energy, and we know that it is pinching, it is binding,
it is distorting disposable income in households. It will
change the way Americans think and react.
That is good in many respects as the markets change and as
a need in pricing for new forms of energy begin to shape the
market and shape our policy, and we see that happening now, Mr.
Chairman, and it is critically important that, in part, it
continue. Renewable fuel standards, diversity in the
marketplace, a full portfolio of energy is increasingly
important. We are all here scurrying to find resources to build
incentives into new technologies and to the laboratory to bring
things to market.
While all of that goes on, clearly, Mr. Chairman,
transparency is important. There is no excuse for profiteering
against the pocketbook of the poor, and the marketplace has to
be transparent so that it is visible when it happens.
We also know, and I have listened to all of the statements
this morning, I don't disagree with most of it. It is a
phenomenally integrated world market with forces and demands
that are new and different and diverse. At the turn of the
century, 4 percent of the energy supply was oil. Today, it is
now 96 percent when we talk about transportation. Whether it is
Caruso or others looking at the markets in the out years, we
know that by 2020, based on current demand curves, that it is
going to be a 60 percent increase in demand. We have got to
diversify. We know that. At the same time, we recognize current
uses and the need to supply those uses.
I am not quite sure that I have any ability to look out 20
years from now and predict what the American economy will be
like based on the adjustments it is currently making as a
result of unprecedented high energy. Speculators will try to
judge that. Markets will try to judge that. At the same time,
in judging it, we ought to demand open and clear transparency
in the markets so that those judgments are sound and so that
the distortion is as limited as possible.
Gentlemen, I am anxious to hear from you.
Senator Levin. Thank you, Senator Craig.
Senator Tester has a statement that shall be made part of
the record. He had to leave to preside.
[The prepared statement of Senator Tester follows:]
OPENING STATEMENT OF SENATOR JON TESTER
Thank you Mr. Chairman,
As the cost of oil has risen to record levels--Montanans along with
Americans from across the country--have had to bear the cost of rising
oil prices whether they are filling up their vehicles, heating their
homes, or buying goods that were transported by truck, ship, or rail.
In the last 15 years, the price of oil has gone from selling
consistently around $20 in the 1990's to $66 per barrel in 2006, and is
projected to average $72 per barrel in 2007 with a possible increase to
nearly $85 per barrel on average in 2008.
Oil prices are a complicated issue with global implications. China,
India and other growing economies will continue to consume larger
quantities of the world's oil supply and the demand will continue to
grow exponentially. Furthermore, natural disasters like Hurricane
Katrina and political upheaval in the Middle-East, Africa and South
America disrupt supplies and increase the cost worldwide.
But the fact of the matter is that 100 dollar oil cannot be
explained by supply and demand alone. Speculation in the crude oil
market is driving up costs and making fortunes at the expense of the
American consumer.
Normally I don't think the government should meddle too much in the
affairs of business, but in the case of big oil companies and the
companies that speculate and trade the product, there need to be some
checks and balances. Energy is an issue with broad economic and
national security implications and without taking steps to slow the
pace of rising energy costs, the economy of our whole nation will
suffer.
This issue also highlights the need of this Congress to pass an
energy bill that creates a comprehensive strategy for energy production
and conservation. It is mandatory that we act to ensure that Montanans
can afford to fill up the tanks in their trucks and farm equipment,
that Minnesotans can afford to pay their heating bills and the small
businesses from New England to California have the resources to pay for
their energy costs. Homegrown fuel, alternative energy and, and better
fuel efficiency can all help get energy costs back in line with
American consumer's ability to pay.
Senator Levin. Senator Barrasso is next.
OPENING STATEMENT OF SENATOR BARRASSO
Senator Barrasso. Thank you very much, Mr. Chairman. While
I am not a Member of this Subcommittee, I am a Member of the
full Committee and the Energy Committee has an open policy of
allowing Members to attend and thank you very much for allowing
me to be here, Mr. Chairman.
Senator Levin. You are welcome.
Senator Barrasso. Coming from Wyoming, whose economic well-
being and tax base is so reliant on oil and natural gas
production, I am particularly interested in today's discussion.
Much of the oil production background is literally discussed
every day around Wyoming's coffee shops. Even in the submitted
testimony, they talk about a differential of $30 per barrel of
oil when one of the refineries was down in Colorado a year ago.
So this is a key point for us.
Our State coffers in Wyoming literally boom and bust on the
prices of energy commodities. Revenues for our schools, our
municipalities, our counties, and the State is closely tied to
energy prices. Significant market moves, whether caused by
natural disaster, by geopolitical forces, or basic supply and
demand, have an enormous impact on my constituents and the
government services on which they rely.
With respect to oil prices and the associated markets, I am
here today to learn from this distinguished panel. From a
legislative perspective, I want to make sure that the Federal
Government is doing the right things, and if the government
policies are causing harm to the market, I want to know about
that and how we can participate.
From the demand side, I am here for my consuming
constituents. As all of the other Members of the Senate
testified, in Wyoming, I think we are even more impacted by
gasoline prices due to the significant distances that my
constituents travel from town to town.
Again, thank you for holding the hearing. I look forward to
the discussion.
Senator Levin. Thank you, Senator Barrasso. Senator
Cantwell.
OPENING STATEMENT OF SENATOR CANTWELL
Senator Cantwell. Thank you, Mr. Chairman. I, too, want to
add my thanks to you for holding this hearing. This is an issue
that I have been involved in following since 2002 with Senator
Feinstein when I first cosponsored her legislation regarding
derivatives. I should just say that that experience, having
dealt with the manipulation of electricity markets, with the
perpetration of specific schemes to manipulate price, led us to
an oversight and investigation about what statutes really are
in place to protect consumers from these kinds of activities,
whether they are the manipulation of physical supply and
demand, or in this case that we are discussing today, in the
moving around of resources.
I want to say to you, Mr. Chairman, I believe it is the
Permanent Subcommittee on Investigations and their continued
focus on this issue that will actually bring us results,
because you are saying that we are going to hold the agencies
accountable for the oversight that needs to happen here. So I
want to thank you personally for your due diligence and to the
Ranking Member, as well.
This simply today is a question about why oil should
receive special treatment as a commodity that is traded. Now,
when we look at this, this commodity, if you want to say that
it is a commodity, we are spending $1 billion a day importing
oil, and yet oil does not have the same regulations that other
commodities have. They don't have the same recordkeeping, the
reporting, the market surveillance, and the detection to
prevent price manipulation, distortions, curbs, and excessive
speculation and various other financial standards.
Now, why in America do we regulate, as I have heard before
at various committees, things like corn, hamburger, orange
juice, but when it comes to oil, we seem to think that it
shouldn't have the same market transparency functions and
market oversight of those other products?
And when people tried to say in the past, it is about
derivatives, that somehow derivatives is too complicated for
Members of the U.S. Congress to understand, they are wrong. We
understand what is going on, and derivative contracts based on
commodities, of agriculture commodities, cannot be traded on
the future exchanges without those regulations. So you can't
say that it is about derivatives because we have derivative
agriculture products that we are not allowing to be over-the-
counter trades. We are saying, no, there has to be
transparency. There has to be reporting. There has to be
bookkeeping. We have to be able to go in and see if
manipulation has occurred.
So the fundamental question here today is why should oil be
allowed to be traded on the ICE Exchange, on an international
exchange, without the oversight to prevent, as my colleagues
have already pointed out, that manipulation and speculation are
not driving this market?
Now, there are lots of issues about speculation. There are
lots of issues about speculation in any market. But that is why
you have rules in place. That is why you have reporting. That
is why you have accounting. That is why you have bookkeeping,
so you can go back and track and make sure that it is not, as
some people have been in my office saying, some of those in the
energy field who probably don't really like that their price
has been speculated by hedge funds, that somehow people are
holding supply off the shore, as my colleague Senator Wyden
said, just to drive up the price so that 3 days later they can
get the best price for the market.
Consumers are getting squeezed, and in my State, I just
came back from looking at the flood damaged areas of Washington
State and we are still paying over $3 a gallon for gasoline and
still pay the highest in the Nation, along with California and
Oregon. We cannot let a commodity like energy, which is the
lifeblood of our economy and affects so many other areas of how
well our economy will do, to continue to have these loopholes,
and I hope that the gentlemen testifying today will help
elaborate about why transparency and recordkeeping is so
important to protecting the consumers and the price they pay at
the pump.
I thank the Chairman.
Senator Levin. Thank you very much, Senator Cantwell.
Senator Menendez.
OPENING STATEMENT OF SENATOR MENENDEZ
Senator Menendez. Thank you, Mr. Chairman. I want to thank
you and the other leadership of our respective Committees here
for calling this hearing.
Oil prices and the market that set these prices are
incredibly important to the world's economy, but it is also
important to every aspect of working people's lives. Right now,
Americans are paying twice as much for gasoline than they were
5 years ago, and if the price of crude jumps again as we
approach next year's summer driving season, it would not be
surprising if the price of gasoline reached $4 a gallon. The
constant squeeze our citizens feel on their bank accounts are
not isolated to gasoline, of course. The winter that we are
upon is already seeing record home heating prices, which is
devastating, particularly for those on a fixed income. And in
addition, any product that needs to be transported to market is
becoming more expensive as the cost of transportation rises and
the domino effect, the ripple effect, continues.
With the unchecked rise in oil prices, people are losing
faith in our markets. They see oil companies pocketing record
profits. They see greedy market manipulators like Enron and
Amaranth being caught and brought to justice, but they do not
see actions being taken to make sure such crimes do not happen
in the future.
And Mr. Chairman, when we see the difference between the
extraction price, in essence, what it costs to physically
extract a barrel from the ground, and where oil is being sold
at today, we see that there is a very significant difference,
and whether that is by possible manipulation or a lack of
transparency, I think the consumers have a right to have faith
in this market of such an incredibly important commodity in
their lives.
And at the same time, moving beyond the domestic for a
moment to the international, it seems to me that this is a huge
boon to oil exporters who reap the benefits, as well, like
Iran, which we are all engaged in a great debate on these days.
There are some estimates that they are getting another $5.5
billion extra a month because of this premium, so to speak. So
it is interesting. We talk about sanctions. Just the call for
sanctions raises the price of the oil, therefore giving Iran
more money.
We look at this whole process and the lack of transparency
and manipulation, and I agree with Senator Cantwell about why
should oil be the one commodity, and that is why I am proud to
have joined you, Mr. Chairman, in your legislation. I am an
enthusiastic cosponsor of your Close the Enron Loophole Act and
I am hopeful that this will give us the opportunity to ensure
that our markets function properly and restore people's
confidence specifically in the commodities markets that are so
critical in their personal lives, and I look forward to the
testimony of the witnesses.
Thank you, Mr. Chairman.
Senator Levin. Thank you, Senator Menendez. Senator
McCaskill.
OPENING STATEMENT OF SENATOR MCCASKILL
Senator McCaskill. Thank you, Mr. Chairman. As others have
said already this morning, in the last 5 years, we have seen
almost a 100 percent increase in speculative trading on crude
oil futures and that is just the trading we know about. That
doesn't count all the trading we can't track that is not
through a regulated exchange.
During that same period of time, as Senator Menendez said,
gas prices have doubled. The purpose of this hearing is to try
to figure out what is driving that increase.
Well, I am positive of one thing. I am positive that
America's middle class and working families are not behind the
wheel driving this increase in speculation. Something has
changed that is causing this massive amount of speculation that
we have not seen before, and I think it is hard for us to
imagine that it is not connected to the massive increase we
have seen in gasoline prices for the people that I represent in
Missouri. Greed is driving the speculation and grossly
inadequate oversight to prevent manipulation.
Who benefits from the unregulated markets? I think that is
the question that we must try to answer today. I hope that the
witnesses will think about that question in the context of
their testimony. Who is benefiting from the unregulated
markets? Speculators, no question about it. Oil companies, hard
to imagine they are not, but we need to figure that out.
Missourians who are paying more for gasoline than they ever
imagined possible, I don't think so.
I think it is very important that we try to get to the
bottom of this, and we all understand, and I don't think we
need to be told, the importance of liquidity in commodities
markets. But as Senator Cantwell so articulately said, this is
a commodity. It should be treated no differently. And until we
treat it the same as other commodities, the American public is
always going to assume that they are getting the short end as
opposed to those who are sitting at the trading table making
hand over fist.
Thank you, Mr. Chairman, for holding this hearing today. I
appreciate the opportunity to make a statement.
Senator Levin. Thank you, Senator McCaskill.
Let me now welcome our panel of witnesses to this morning's
hearing: Guy Caruso, Administrator of the Energy Information
Administration at the U.S. Department of Energy; Fadel Gheit,
Managing Director and Senior Energy Analyst at Oppenheimer and
Company in New York; Edward Krapels, the Director of Natural
Gas and Power Markets at Energy Security Analysis, Inc., in
Wakefield, Massachusetts; and Philip Verleger, Jr., President
of PK Verleger, LLC, in Newport Beach, California. We welcome
you this morning to this joint hearing of our two
Subcommittees.
Pursuant to Rule 6, all witnesses who testify before the
Permanent Subcommittee on Investigations are required to be
sworn. Since this is a joint hearing, we will follow that rule.
We would ask all of you to please stand and raise your right
hand.
Gentlemen, do you swear that the testimony you are about to
give before our two Subcommittees is the truth, the whole
truth, and nothing but the truth, so help you, God?
Mr. Caruso. I do.
Mr. Gheit. I do.
Mr. Krapels. I do.
Mr. Verleger. I do.
Senator Levin. A timing system today will give you a yellow
light about 4 minutes from the time you begin, giving you a
minute to conclude your remarks. We would very much appreciate
it if your oral testimony consumed 5 minutes. We will put your
full statements in the record, of course, and we will start
with you, Mr. Caruso. Thank you for being here.
TESTIMONY OF GUY F. CARUSO,\1\ ADMINISTRATOR, U.S. ENERGY
INFORMATION ADMINISTRATION, U.S. DEPARTMENT OF ENERGY
Mr. Caruso. Thank you very much, Mr. Chairman, Chairman
Dorgan, and Members of both Subcommittees. It is an honor to be
here to discuss recent developments in crude oil markets and
the factors contributing to the increase in petroleum prices.
The Energy Information Administration is the independent
statistical and analytical agency within the Department of
Energy. Our views are strictly those of EIA and should not be
construed as representing those of the Department or the
Administration.
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\1\ The prepared statement of Mr. Caruso appears in the Appendix on
page 67.
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Oil prices have trended upward over the past several years,
as a number of the other witness statements have indicated. The
price of West Texas Intermediate (WTI), crude oil has climbed
from $56 on average in 2005 to almost $100 per barrel last
month. With these rising prices, oil markets have drawn the
increasing interest and participation of investors and
financial entities who do not directly engage in physical oil
markets.
The precise impact of these non-commercial market
participants, as Senator Wyden pointed out, is difficult to
assess. EIA believes that tight supply and demand fundamentals
are the main drivers behind the rise in oil prices over the
last several years. These factors include strong world economic
growth, leading to increases in consumption; moderate growth in
supply from non-OPEC nations; production decisions by members
of OPEC; low spare production capacity in the world; tight
global commercial inventories; refining bottlenecks around the
world; and ongoing geopolitical risks and concerns about
supply.
Strong economic growth around the world continues to foster
strong oil demand growth, with China, other developing
countries in Asia, and the Middle East countries projected to
account for a large share of the total world oil consumption
growth this year and in 2008. At the same time, growth in non-
OPEC production has been significantly less than growth in
consumption. This is concentrated in a few areas and there have
been project delays and increasing decline rates in Mexico, the
United Kingdom, and Norway. As a result, supplies must
increasingly come from OPEC members or from inventories.
OPEC members have altered production targets over the past
few years, thereby keeping markets fairly tight. EIA expects
OECD commercial inventories measured on a days supply basis to
remain in the low end of the 5-year range in 2008.
World surplus production capacity is expected to remain
fairly low, averaging two to three million barrels per day
through 2008, leaving the market vulnerable to unexpected
supply or demand events that put upward pressure on prices.
Because of the lack of supply or inventory cushions and low
short-term price responsiveness of demand, large price
increases are required to rebalance supply and demand.
In the downstream markets, there is a low level of excess
refinery capacity worldwide, which reduces flexibility when
supply and demand balances are tight or there are unplanned
refinery outages.
Geopolitical instability in many OPEC as well as non-OPEC
countries also puts additional upward pressure on inventory
demand and crude oil prices.
Some oil market observers are citing speculation as the
main driver of the current high prices. However, the staff of
the Commodity Futures Trading Commission have analyzed the
behavior of managed money traders and found that they are most
likely to follow than to lead position changes by other market
participants. There have been many instances over the past few
years when crude oil futures prices have risen along with an
increase in the net long positions of non-commercial
participants, that is, more buyers than sellers. However, there
have been key periods in which the net position of these non-
commercial participants did not move in the same direction as
prices, particularly in July and early November of this year.
It appears that any correlation between speculative
activity and rising prices is loose, at best. Evidence,
reinforced by the CFTC study, suggests that speculators shift
positions in response to price changes. If the tight supply and
demand conditions weaken or are expected to weaken, we would
expect speculative activity to decline, as has been seen very
recently. Speculators and others are investing in oil markets
because of tight market fundamentals and geopolitical security.
Increased speculative activity is more of a symptom of market
conditions than the cause, in our view.
This completes my oral statement, Mr. Chairman, and I would
be glad to answer any questions at the appropriate time.
Senator Levin. Thank you very much, Mr. Caruso. Mr. Gheit.
TESTIMONY OF FADEL GHEIT,\1\ MANAGING DIRECTOR AND SENIOR OIL
ANALYST, OPPENHEIMER & CO., INC., NEW YORK, NEW YORK
Mr. Gheit. Thank you for having me. I have over 30 years of
energy industry experience, the last 21 years as an analyst on
Wall Street. My view, which represents my own and does not
represent the company that I work for, which is Oppenheimer and
Company, oil is unlike any of the commodities that we deal
with. It is critical to global economic growth and our national
security. It impacts our lives, influences our national
policies, both domestic and foreign, and is likely to play a
key role in shaping our future.
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\1\ The prepared statement of Mr. Gheit appears in the Appendix on
page 76.
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Over the last 40 years, oil prices fluctuated from under $3
to a record of more than $98 only a few weeks ago. Oil traders
and the media were cheering the rising oil prices and hoping
for oil to break the $100 mark. Some analysts even predicted
that oil prices are heading for $120 by the end of this year
and expect it to be between $150 and $200 next year.
I don't know where oil prices will go next month or next
year, but I believe that the current high oil prices are
inflated by as much as 100 percent. I don't think industry
fundamentals of supply and demand justify the current high
prices, which I believe are driven by excessive speculation.
Based on various press accounts, others who share this view
include our Energy Secretary, most OPEC ministers, and the
heads of major international oil companies.
Oil prices were close to $60 per barrel in August, rose
sharply to almost $100 in November, although there was no
changes in world supply and demand. The price surge, in my
view, was a result of excessive speculation about potential
supply disruption in the event of a military attack or strike
against the Iranian nuclear facilities. The passing of the
Senate resolution regarding the Iranian Revolutionary Guard as
a terrorist organization seems to have been the catalyst
speculators needed to fan the fire. The drop in the value of
the U.S. dollar against major currencies also pushed for higher
oil prices.
No one has been able to accurately and consistently
forecast oil prices, not oil companies, government, or people
on Wall Street. However, this lack of reliable oil price
forecasting has created a vacuum that has been filled, in my
view, by financial players with very short investment horizon,
which significantly increased the price volatility.
Globalization of the financial market, ease of trading, rapid
movement of large sums of capital, information overflow, and
increased global tension have created an ideal environment for
excessive speculation in the world market.
Oil price volatility has attracted a large and growing
number of speculators seeking the highest profit in the
shortest time. Volatility, however, has an adverse impact on
the oil industry because it increases uncertainty and distorts
market fundamentals, which could result in poor investment
decisions in securing adequate supply to meet world growing
demand for oil.
The oil industry operates in an environment driven
primarily by factors it does not control--global economic
growth, increased world oil demand, and reduced OPEC spare
production capacity to historically low levels. Non-OPEC
production is hampered by project delays, rising costs, and
technical problems. These factors increase the risk of
potential supply tightness.
I believe that the oil markets need assurances from leaders
of both major exporting and major importing countries as well
as the oil industry. People need to know that the world is not
running out of oil, that supplies are adequate, and that global
stockpiles are sufficient to make up for any potential supply
shortfall or demand surge. It is worth noting that the current
global oil inventories of more than four billion barrels exceed
the oil export volume from Iran for more than 2\1/2\ years, and
Saudi Arabia for 15 months, and the entire Middle East for 6
months.
I believe that oil speculators use weekly petroleum data
published by the Energy Information Administration to
manipulate oil prices for their short-term gain. Speculators
have used declining inventory levels to spread fears about
potential shortages, when in fact it indicates exactly the
opposite. Reducing inventory levels improves capital
efficiency, especially in a high oil price environment. In
addition, oil price backwardation makes it even more prudent
for the oil industry to reduce inventories further. But more
importantly, declining inventories, in my view, underscore that
the industry is less concerned about shortages and is more
confident about supply availability.
While oil trading helps with its long-haul crude shipment
against price volatility, I believe it should be regulated to
ensure transparency, discourage excessive speculation, and
prevent potential conflict of interest and abuse by traders.
Several measures should be considered to regulate oil trading
by financial players, including major investment banks, the
commodity traders, hedge funds, and private equity funds. These
include raising the current margin requirement to 50 percent of
the value of the trade; setting limits on the number of oil
contracts by each account; establishing a minimum holding
period to hold these contracts; preventing conflicts of
interest by financial institutions; and finally, imposing stiff
penalties on violators, including minimum jail sentences. Thank
you.
Senator Levin. Thank you very much, Mr. Gheit. And now, Mr.
Krapels.
TESTIMONY OF EDWARD N. KRAPELS,\1\ SPECIAL ADVISOR, FINANCIAL
ENERGY MARKET SERVICES, ENERGY SECURITY ANALYSIS, INC.,
WAKEFIELD, MASSACHUSETTS
Mr. Krapels. Good morning. Thank you, Mr. Chairman,
Senators. Thank you very much for the invitation to come here.
I am speaking today as a representative of my consulting
company, Energy Security Analysis. We have been in the oil
market forecasting business for 25 years, and as a matter of
corporate survival, we have to take into account all the
factors that influence oil prices.
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\1\ The prepared statement of Mr. Krapels appears in the Appendix
on page 78.
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About 10 or 15 years ago, we began to divide the oil world
into two sets of forces, physical and financial, and so you can
see that from our perspective, we look at the fundamentals of
financial markets as being as important to the price of oil and
gas as the fundamentals of physical markets. That is my first
point.
Let me make four more practical points, because my old
friend Phil Verleger is here and he is a true economist and I
am a practical economist. Let me make four points as a
practical guy.
The discussion about the proper influence or how to depict
the influence of speculators on oil prices to me often achieves
a level of how many angels can dance on the head of a pin. When
you get formal trained economists to address this problem, they
will usually say, ``I am sorry, we can't find a correlation.''
But when you look at the market from the standpoint of a
practitioner or people in the financial business, you will hear
anecdotal evidence all the time that of course, financial
trading is influencing the price of oil. I am in that camp.
Of course, financial trading and speculation affect the
price of oil because they affect the price of everything we
trade. We live in a trading culture. We have funds that flow
out of the dot-com sector into the housing sector, out of the
housing sector into the commodities sector. Wherever these
trillions and trillions of dollars go, they affect the price of
whatever it is that they are trading. It would be amazing if
oil somehow escaped this effect.
So there is a bubble in oil prices that has lasted for
several years, and in my opinion, it will last for several more
years because the underlying condition of the world oil market
is extremely tight and the demand responses, unfortunately, are
very slow.
My next point is do we have information that indicates how
this mechanism works, and I suggest that the outstanding work
done by your own staff on the Amaranth case and published last
year in your special report constitutes the best piece of work
I have seen in this respect and I congratulate the staff for
the outstanding work that they did. Clearly, here was a market
that was manipulated by a very large trader that from time to
time had 40 or 50 percent of the open interest in the NYMEX
market, and that was only the visible market because we didn't
know how large their positions were in other markets. So for
me, the debate is over. Of course, speculation affects
commodity energy prices. There is no question about it.
My next question, though, is what do you do? What do you do
about that? I think that Mr. Gheit has told you, and I think
your own staff has told you the things that need to be done.
You do need to regulate these markets in the way that you have
traditionally regulated these markets. I come out of the R.H.
Coase School at the University of Chicago. R.H. Coase pointed
to a paradox decades ago. He is a Nobel Prize winning
economist. He said, isn't it paradoxical that the best markets
have very clear regulation, and he pointed to American
commodity markets as prime examples of that effect.
We need to simply hold all the exchanges that trade energy
to the same standards that we hold the New York Mercantile
Exchange. I think the New York Mercantile Exchange is an
outstanding market. The WTI market is a wonderful market. We
simply need to have more disclosure, more information about how
these other markets trade.
The solution to the problem of what do we need to do about
these exchanges is simple to me. It is disclosure, disclosure,
disclosure. We simply don't have enough information. When your
staff got the information through their subpoenas, they were
able to see the effect that Amaranth had. The rest of us,
including my clients, which include universities and people who
buy oil, would love to have had that information about what the
effects of the speculation on natural gas prices was, but we
didn't have it because the CFTC didn't release it.
So my last point, and this is awfully important, I think
futures markets, like all the rest of you, I think futures
markets are invaluable, that we need the liquidity, we need the
financial services, we need the ability to hedge. So whatever
we do, we mustn't throw out the baby with the bathwater. It is
not an onerous obligation to say to the futures markets in
energy, hold to these high standards that the NYMEX has. If we
do that, I believe that we can have very effective oil and
natural gas and power forward markets that are in the interests
of all of us. Thank you very much.
Senator Levin. Thank you very much, Dr. Krapels. Dr.
Verleger.
TESTIMONY OF PHILIP K. VERLEGER, JR.,\1\ PRESIDENT, PK
VERLEGER, LLC, ASPEN, COLORADO
Mr. Verleger. Senator Levin, thank you very much. Thank you
for your kind comments on your introduction. It is a pleasure
to appear here again and I thank the Senators for coming. It is
a real pleasure to appear in this famous hearing room.
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\1\ The prepared statement of Mr. Verleger appears in the Appendix
on page 98.
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Let me associate myself with Mr. Krapels's comments and
especially with the comments on the Subcommittee's report on
Amaranth. I have been studying the futures markets as an
academician and policy maker for 20 years--and that report is
the best. I learned more from it, particularly the deep data
digging.
Senator Levin. Thank you.
Mr. Verleger. This is an important hearing, particularly on
oil prices, and let me summarize my testimony. It is 20 pages
and I will do it in 4 minutes.
The rise of prices to almost $100 a barrel is first led
this year by the removal of light sweet crude oil from the
market by DOE beginning in the middle of August.
Second, the price has also been pushed higher by
liquidation of inventories. Senator Wyden would like to see
inventories lower. We are all going to see substantial
liquidation of inventories. Inventories are built or liquidated
according to profit incentives. The incentives to hold
inventories were profitable last year and in part by investment
in passive futures. They are not profitable now and we are
seeing massive liquidation.
Third, sweet crude oil demand is being boosted by
environmental regulations, particularly the new regulations
requiring the limit of sulfur to 10 parts per million in both
the United States and in Europe in diesel fuels.
Fourth, I have been studying the oil market since 1971 and
have been policy maker. I can't find any international event
which explains why oil prices have risen recently. And as I
said, I have been writing about commodity markets, studying
futures markets. I think this is speculation.
Let me start my prepared testimony at Figure 1 on page
three of my prepared statement.\1\ I show there the price of
WTI from January through December last year and January through
November of this year. In that graph, I have taken the price of
WTI from February through this last August by calculating the
price of Brent and adjusting it using the traditional
differential because the WTI market, as Senator Levin noticed,
was distorted with the shutdown of a single refinery, the
Valero McKee refinery.
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\1\ Figure 1 appears in the Appendix on page 100.
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If you look, the price last year up until August was
identical, within 50 cents to a dollar a barrel, to this period
of time. Then, since August, we have had the largest increase
in prices in 30 years in absolute terms. It exceeds the price
increase for the fall the Shah fell. It exceeds the price when
Iraq invaded Iran. And it exceeds the price increase that we
saw in 1990 when Iraq invaded Kuwait.
Why is this? Well, if you look at a series of factors as a
detective you cannot find any event such as a change in demand
in China or in India this year to explain the increase. You
also cannot attribute it to a shortage of crude oil on world
markets. Between August and December, Saudi Arabia cut its
price of oil by $10 a barrel. The Saudis couldn't sell their
crude. You also can't explain it at this point by speculation.
Now, in speculation, I want to distinguish between
investors and speculators. Investors have poured billions of
dollars--and if you turn to Figure 4 on page six of my prepared
statement to a graph we prepared \2\--into passive investment
vehicles, the Dow Jones AGI Index and the S&P Goldman Sachs
Index. These are pushed by academics who argue that, in fact,
commodities are an investment class. They earn returns like
bonds and like assets and it is better to invest in these
diversified commodities than, say, an oil company. We have seen
money go up, but it is steady. It is not volatile.
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\2\ Figure 4 appears in the Appendix on page 103.
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You can, to a certain extent, explain the price increase by
the change in the profitability of holding oil, and I show in
Figure 8,\3\ nine graphs which show the return on investment,
that is how much money a company made, and last year, companies
could buy oil, put it in tanks, and earn a return that was
seated on bonds. Not now.
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\3\ Figure 8 appears in the Appendix on page 106.
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But the big change that came since August of this year was
the decision to put oil in the SPR, to take royalty in kind,
and the decision to take sweet crude oil, because the sweet
crude oil they are taking accounts for between three-tenths and
six-tenths of a percent of the world's available sweet crude
supply. Only 6 million barrels a day of world supply qualify
for going into sweet crude for the SPR. Given the pressure for,
need for light sweet crude, particularly in refining to make
the low-sulfur diesels and other low-sulfur products, this has
created a tightness on the market. If you apply the standard
price elasticities, and Senator Dorgan taught economics, for
demand for crude oil, particularly the ones Professor Nordhaus
has produced at Yale, you come to the conclusion that this
probably added $8, maybe $5, maybe as much as $10 a barrel to
the price, just in terms of demand.
This then was magnified by what is called delta hedging in
the market. Many consumers have hedged their fuel costs using
options. To do this they buy options so that if the price goes
up, they still get their oil at $50 a barrel. This is a good
way of hedging.
But as the price goes up, the firms that have written those
options have to buy more crude. Last year, when the prices
started to fall after August 18, producers of crude oil who had
bought puts were protected and the financial firms sold
futures, so what happened is prices fell, say, to $60 on a
cyclical decline and they were pushed down to $50 a barrel by
what we call delta hedging in the financial community.
This year, as the price has been pushed up from $75 to $80
as oil was added to the SPR. This created a need by the banks
and the other financial institutions that have written the
options to buy oil futures. The purchases accelerated the price
rise to $100.
Now, my view--and I have always been an outlier of views on
oil markets--this view is not widely held and I commend the
Department of Energy, we are going to get a test of how right I
am because they are going to double the rate at which they put
sweet crude oil into the market over the next 6 months, from
January until June.
Senator Levin. Into the market?
Mr. Verleger. Into the Strategic Petroleum Reserve. Excuse
me. If, in fact, I am right, we are going to see prices be
magnified up again by delta hedging because the physical
refiners who need the light sweet crude will be bidding the
price higher. They will be competing with DOE and we could see
prices, if the experience from last August to November applies,
we could see prices go, say, to $120 a barrel. If I am wrong,
and I hope I am wrong, it won't happen. But all the economics
now plus the way people hedge in terms of using options,
particularly the airlines, other end users, set us up for an
even larger price increase over the next 6 months.
Thank you very much, and I am sorry to have gone over my
time.
Senator Levin. Thank you very much, Dr. Verleger.
Mr. Caruso, let me start with you. Exhibit 14, if you will
take a look at it, it shows that the number of speculative
trades in crude oil has tripled from 2000, and these trades
from speculators used to make up 15 percent of the outstanding
crude oil future contracts on NYMEX.\1\ Now they make up 35 to
40 percent of the outstanding contracts, so-called open
interest. Is that dramatic increase shown by that chart in
outstanding crude oil future contracts relevant? Might it be
relevant in terms of oil prices? Just might it be relevant?
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\1\ See Exhibit No. 14, which appears in the Appendix on page 201.
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Mr. Caruso. Definitely. I would agree with Mr. Krapels's
comments that speculative trading has had an impact on the
market. My distinction is it is not the cause of the rising
prices, it is following the market up.
Senator Levin. Well, you said it had an impact----
Mr. Caruso. It is not the driver of the market. It is part
of the reason prices have gone up. We are not saying that it is
irrelevant. It is definitely relevant and it is definitely part
of the reason that we are seeing prices go up. We are just
saying we can explain most of the change by the fundamental
factors and the geopolitical risks----
Senator Levin. Right. It might be a cause of increased
prices?
Mr. Caruso. It is part of the combination of factors.
Senator Levin. So it may--I am not saying it is the cause.
I am saying it might be a cause.
Mr. Caruso. It is one of the many causes, yes.
Senator Levin. What are you doing to determine the extent
to which it is a cause? In your statement, the Energy
Information Administration issued a report a few weeks ago that
says, with the rapid rise in prices, oil markets have been
drawing increased interest and participation from investors in
financial entities without direct commercial involvement in
physical oil markets. Those are folks we call speculators. The
role of these non-commercial future markets participants in
recent price developments is difficult to assess.
Mr. Caruso. Yes.
Senator Levin. Now, since there, in your judgment, may be a
cause, and you are the most cautious on that--at least our
other witnesses say they are clearly a cause, but your
Administration says they might be a cause--instead of looking
at the extent to which they are a cause, you turn to general
principles. You say, let us focus instead on general principles
because that favors a focus on fundamentals rather than
consideration of alternative price drivers.
Well, fundamentals obviously also have a major role, but
since this amount of speculation even in your judgment may be a
cause, and you are the most understated witness we have got
here, but nonetheless it may be a cause, I want to know why
your Administration is not acting to determine the extent to
which it is a cause. Instead, you just simply go back to, we
are going to look at the fundamentals.
Mr. Caruso. We look at all----
Senator Levin. Why don't you look at that?
Mr. Caruso. We are looking at all the factors and----
Senator Levin. To what extent are speculators a cause?
Mr. Caruso. I don't think it is possible to actually
accurately estimate the dollar amount, but----
Senator Levin. How about a percentage?
Mr. Caruso. I don't think it is possible.
Senator Levin. But are you trying?
Mr. Caruso. And what we do is rely on those who are
providing the oversight and the enforcement, such as CFTC, and
we rely on the studies that they have done and their studies
show that it is not the fundamental cause of the prices going
up.
Senator Levin. So long as it may be a cause, it seems to me
you are not doing your duty by not looking at the extent to
which it is a cause. You have got very capable people,
including witnesses sitting right next to you, who believe it
obviously has a significant impact, and yet your
Administration, which is supposed to determine these kinds of
issues, has basically delegated that to someone else, and that
is a major problem, I believe. And so all we can do is tell you
that we think--I am speaking for myself, obviously--that the
Department of Energy is failing to do what consumers in this
country rely upon you to do, and that is to look at the causes
of these oil prices skyrocketing. You have abdicated that. You
have delegated that. You acknowledge it may be a cause, this
excessive speculation, and yet you have not done your own
analysis.
Finally, before my time runs out, let me quote not just the
Exxon Mobil chairman that was already quoted here this morning,
but also Lord Browne, who when he was the BP Group chief
executive said the following recently in 2006. ``There has been
no shortage of inventories of crude oil and products have
continued to rise. The increase in prices has not been driven
by supply and demand.'' You disagree with that, is that true?
I want to repeat it. ``The increase in prices has not been
driven by supply and demand,'' Lord Browne.
Mr. Caruso. I think the increase in prices has been
determined by supply and demand and other factors, such as
geopolitical risks which also have contributed to the
speculation, in a sense, is what we are saying. It is a
combination----
Senator Levin. Whatever has contributed to the speculation,
wouldn't you agree that the tremendous increase in the amount
of speculation that has gone on is likely to be a factor in the
increase in prices? Can we get that much out of you?
Mr. Caruso. I would agree, it is a factor, and our analysis
of the fundamentals indicates it is not a large factor, and we
have done our diligence on this and we think it is part of the
factor, but not a major factor.
Senator Levin. Well, the diligence that you refer to is the
CFTC that you have delegated this assessment to.
Mr. Caruso. No, we have done our own work and then we have
looked at other studies, such as CFTC, such as the IMF, other
academics who are experts in the field of oversight and
enforcement in the financial and commodities markets.
Senator Levin. OK. My time is up. Senator Dorgan.
Senator Dorgan. Mr. Chairman, thank you very much.
Mr. Caruso, I have been looking at your appropriations. I
chair the Appropriations Subcommittee that funds the EIA and I
was in the last week taking a look at how many people we have
down there and what we are getting out of EIA, and I was just
thinking about this as you were answering these questions. Your
organization plays a very important role and has a very
important function and Senator Levin is trying to understand
what appears to be a contradiction.
I think what you are saying today is that the fundamentals
exist that are supportive of the current price trends in oil.
Do you mean that you look at the fundamentals and say you
believe the fundamentals support and justify what is happening
to prices.
Mr. Caruso. Not ``justify.'' I am saying that we can
explain the behavior of the oil market by looking at the
fundamentals of supply and demand and the other factors that go
into decisionmaking by participants in the marketplace, such as
concern over Iran, Iraq, and Nigeria. So it is a combination of
all of those factors.
Senator Dorgan. Let me put up a chart.\1\ Again, when I was
looking at it, we spend about $100 million a year, roughly, for
what you all do, and I want you to do it and do it well and
provide us a lot of very important information. We need you to
do your job well.
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\1\ See Exhibit No. 8, which appears in the Appendix on page 129.
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One of the witnesses mentioned the decrease in the price of
Saudi light crude relative to the price of west Texas
Intermediate crude since May 2007. Since May 2007, the spot
price of oil has skyrocketed $30 a barrel, but the Saudis have
had to continue to discount the price of their Saudi light
relative to WTI crude by pricing it by nearly $10 a barrel
discount.
Now, it seems to me that just suggests that this is not
market fundamentals. There is something upside down, something
not working here. Do you sense that, as well? Is there
something wrong with that?
Mr. Caruso. Well, one of the factors that is not reflected
in this chart is that at the same time as prices were behaving
such as they are shown here, the Saudis were actually reducing
production.
Senator Dorgan. But that is not the issue. The issue is at
what price are they selling what they produce? You have just
changed the subject on me.
Mr. Caruso. Yes.
Senator Dorgan. When they have to discount by $10 a barrel
what they are selling, isn't that at odds with the suggestion
that the market system is working, that the fundamentals of
supply and demand somehow work? It seems to me that
relationship is counter to that. Do you agree with that?
Mr. Caruso. I would agree with that. But at the same time,
the Saudis have been leaders within OPEC to try to prop up the
price of oil through----
Senator Dorgan. Again, a different subject, but let me go
to a couple of the other witnesses. I am trying to understand
what we are learning here. It seems to me that there is a
massive amount of speculation occurring, and one of the
witnesses--maybe it was you, Dr. Verleger--you talked about the
DOE's decision to fill the SPR, and I want to come back to Mr.
Caruso to see whether DOE got information from you about what
the impact of that might be.
You talk about the price impact of the decision to fill the
SPR with sweet crude and that the total world market for that
is five million barrels, and then you indicated that was
amplified by option hedging. I want to try and understand that
a little more. Can you amplify on that?
Mr. Verleger. I would be happy to, sir. There are a number
of types of derivatives. The futures is the standard that we
have had for 150 years. There are options on futures, through
which a firm takes a long position or a short position. It is
not obligated to take delivery. The option is essentially an
insurance policy.
So Southwest Airlines has bought call options on crude oil
that keep its cost of crude oil at about $50 a barrel this
year, next year, and the year after. That means if the price
falls below $50, they pay a lower price because they are not
required to take delivery.
The firms that write the calls write an insurance policy to
Southwest. These firms will buy futures as prices rise. This is
called delta neutrality. When the prices go up, they buy
futures.
This year, what we have seen is we got the additional
upward push in the light sweet crude price of $5 to $10 a
barrel from the DOE policy. Then the firms that had written
calls to Burlington Northern, to many other major consumers and
speculators who buy calls had to buy futures to protect
themselves. This magnified the price increase. This is why, as
I said, this is the largest price increase in a 90-day period
of time in 30 years.
Senator Dorgan. And that is very important and I appreciate
the answer and the better understanding.
Mr. Gheit, I have seen in print, that you said there is not
any justification for the price of a barrel of oil given the
fundamentals these days to be over $55 a barrel. Is that
correct?
Mr. Gheit. Absolutely.
Senator Dorgan. You feel strongly about that?
Mr. Gheit. The industry can replace a barrel of crude today
profitably and at less than $15 per barrel. There is an old
rule of thumb that you expect the price to be three times what
your replacement cost is, and the industry replacement cost
could be well below $15 a barrel. That is given the fact that
we still have access to reserves who have obviously been
closing down between Russia and Venezuela and elsewhere. But
having said that, rising costs in the industry, and with that
all said, the industry can still be profitable at $45 oil.
Senator Dorgan. One final question, Mr. Chairman. I am
trying everything I can in some sort of an omnibus bill, some
sort of appropriations process, to put a stop to this royalty
in kind, taking sweet crude off the market and sticking it
underground at this point. That is absolutely nuts, in my
judgment. I am running into all kinds of bureaucratic problems
in trying to stop the Department of Energy from continuing that
activity and exacerbating it. But I still hope we can get that
done.
Mr. Caruso, has anybody at the Department of Energy
consulted EIA and asked what the impact would be if we take
sweet crude and start sticking it underground storage at
current prices? Has anybody asked you what the impact would be?
Mr. Caruso. I have not been asked, no.
Senator Dorgan. Should they have asked you?
Mr. Caruso. Well, we are available.
Senator Dorgan. What would you have told them? Would you
have told them what Dr. Verleger just suggested, that it is
going to pump up the price of oil on the markets and it is
going to exacerbate the price problem?
Mr. Caruso. I don't know. Listening to Mr. Verleger's
argument, it seems to be what he is saying is that world oil
prices are really hyper-sensitive to these very small changes
in light sweet crude, and I am unconvinced of that--because we
have had large changes in light sweet crude, such as in
Nigeria, a reduction of 500,000 barrels a day. We have had
nothing like the kind of rise in price that Mr. Verleger has
alluded to in the last part of 2007. So I have trouble
reconciling how such a small reduction of supply of light sweet
crude--I think it is about less than 20,000 barrels a day--
could have caused such a large price change. Whereas in
Nigeria, a much larger reduction, 500,000 barrels a day, did
not cause that big of an increase.
Senator Dorgan. My time has nearly expired.
Mr. Caruso. So I have a problem with----
Senator Dorgan. Mr. Verleger, do you want to respond to
that?
Mr. Verleger. It depends on when the timing of the cut is.
I mean, we had high inventories thanks to the actions of the
financial firms. Mr. Krapels and I were in Vienna a year ago
talking with the OPEC and EU countries about this, and since
the money has come out and the stocks have gone down, markets
are much more sensitive. But Mr. Caruso raises an interesting
question. The royalty in kind oil is oil that is there. It is
dependable. This is an expectation phenomena. And Nigeria's oil
is oil that oil producers always are a little more concerned,
and it goes to another market. The Nigerian oil--well, some of
that oil doesn't come here, so I would have to look at that.
Senator Dorgan. Let me just thank the witnesses, and Mr.
Caruso, I would like you to be the whistle on the teapot here,
but I don't hear a whistle from you. I just hear you sort of
saying, well, things are OK and we look at the market. It all
adds up. I don't think it adds up at all. Mr. Chairman, thank
you.
Senator Levin. Thank you very much. Senator Coleman.
Senator Coleman. I thank you, Mr. Chairman. I am trying to
understand what we do about what we are learning. I think we
have learned in certain Subcommittee investigations that
speculation has an impact. I don't think there is much argument
over that. The question is how much impact, but it has an
impact.
Let me just kind of step back a little so we are all
operating on the same plane, because some of my colleagues have
raised concerns about the Enron loophole. As I understand it,
when we looked at Amaranth, the Enron loophole related to
natural gas and ICE and not having the same transparency in the
ICE market. In terms of oil, as I understand it, what we have
seen with the charts of the Chairman,\1\ at least in the NYMEX
New York market, that is regulated, and ICE, as I understand
it, has moved the oil trading off to London. So that is also
regulated. So I want to make clear, does the Enron loophole
impact the trading of oil? Any of the witnesses there?
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\1\ See Exhibits No. 1 and 3, which appear in the Appendix on pages
118 and 120 respectively.
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Mr. Gheit. Well, the ICE is actually the Intercontinental
Crude Exchange and it is operated in London under the rules and
regulation, but it is owned by a U.S. firm.
Senator Coleman. Right, but the Enron loophole, the problem
we had with natural gas is that there was not transparency.
They were not regulated. At least with, as I understand it, ICE
now has moved off to London and then those are regulated by
London. So in other words, I am always looking to see whether
transparency is going to make a difference here. I am trying to
understand what transparency is. A lot of my colleagues have
talked about the Enron loophole, but that is not the situation
with oil.
In terms of transparency, perhaps Dr. Verleger, what I got
from you was an indication that perhaps we should require
greater transparency in bilateral swaps, and I can tell you in
regard to natural gas, a lot of folks said that would be a
terrible thing and that would have a terrible impact on getting
capital in the marketplace, on the ability to hedge in a proper
way. So are you advocating that we somehow regulate bilateral
swaps and can you tell me how we do that?
Senator Coleman. Dr. Verleger.
Mr. Krapels. He is much better looking than I am.
Senator it is a critical question and it is kind of a
lawyer's question, and I am not a lawyer but I will give it my
best shot anyway. When Mr. Veleger and I were in Vienna a year
ago and we were discussing this issue with the OPEC members and
with the European Union members, they had the same questions
that you have today and what do we do about it.
The issue of communication and harmonization of regulations
between the United States and the United Kingdom is an
important issue and I think the perfect world would be one in
which both countries impose the same disclosure and margin
requirements on all exchanges operating in the oil market. The
British have their own views on this. I think it would be
wonderful for the U.S. Government to reach out to the British
Government and see if that kind of harmonization could occur.
The fear that if the U.K. and Britain somehow teamed up and
had effective regulation of this market, that the markets might
go somewhere else, like Singapore, is a risk I would be willing
to take, because the only places these markets can really work
is in London and New York.
Mr. Verleger. You said U.K. and Britain. Do you mean the
U.K.----
Mr. Krapels. I am sorry, the U.K. and the United States.
Mr. Verleger. I think it is key in looking at this, is
transparency. Position limits are also important. If you read
the Amaranth report, the ability of Amaranth to act was
limited--NYMEX was watching them. They moved their business off
to the ICE. It has always been important in terms of commodity
markets to have some sort of position limits and exemptions.
Now, I spent a long time taking apart the collapse of Metall
Gesselshaft for their side and they managed to skirt around the
position limits and their actions actually depressed the price
of crude oil through their trading by about $8 a barrel in 1993
to 1994.
So as you look at this, it is position limits, oversight by
these regulatory bodies, and NYMEX does a great job, and the
NYMEX is losing business because of this movement. So the
harmonization. Those two requirements, because the light of
day, that is what Enron didn't want, and just getting those
things would take us a long way.
Senator Coleman. It is your testimony that I think I heard
about regulating bilateral swaps. I have a question with
transparency for Dr. Verleger. Again, though, understanding
position limits, understanding transparency, which you have in
the NYMEX, you have somewhat in the London exchange, are you
advocating that somehow there should be greater regulation of
bilateral swaps?
Mr. Krapels. Well, the ICE exchange by nature is a
derivatives market and I think you can probably apply some sort
of filter that says below a certain volume level, you do not
need to regulate. But when you have these central core
contracts like WTI and rehub [ph.], those, I think, should be
fully disclosed.
Senator Coleman. And then the last thing is Dr. Verleger
raised a very ominous prospect about continuing to put sweet
crude in the SPR. Would it make a difference, then, if
regulation were changed so that we could use sour crude? Would
that somehow diminish the ominous forecast that you have
provided?
You responded to Mr. Caruso's concern about Nigeria by
saying, well, that goes to a different market. My sense in oil
is that these markets are malleable, unlike gas where there are
different markets. Wouldn't you admit that oil markets are not
focused here or focused there? Ahmadinejad does well, whether
we buy it from Iran or not.
Mr. Verleger. Well, there are two things. One, in a future
hearing, you are going to talk about the way the Chinese are
lining up some supplies. There are at least 400 different types
of crude. A number of these crude streams are, in fact, locked
up under long-term contracts. That is, the oil will go to
specific consumers, like the Algerian crude tends to all go to
Italy. The price is set off the market. It used to be there
were official prices. It is now tied to WTI or to Brent or to
Dubai. But diverting the oil to a different source is hard. I
went through and I tried to trace out where some of this
Nigerian crude is going and I just, frankly, don't know--forget
which of the supplies got disrupted.
So yes, it is fungible to a certain point, but that gets
back to the other thing. The reason light sweet crude is so
valuable is that we have now gone to these very tight
environmental specifications and so refiners can take the
three-tenths percent sulfur crude and run it through a unit and
it doesn't slow down the desulfurization units.
The IEA has written several studies in their Monthly Oil
Market Report that worldwide in Europe and now the United
States, refinery utilization rates are going down because of
these new desulfurization rules. The units don't work as well.
Tesoro just last week reported they are having longer delays,
and the long-term experience in California and the West Coast
where we have had lower sulfur requirements is that we lose
three percentage points of operation.
In these circumstances, what I understand from people who
run refineries, and in one way it is saying it is making
sausage, except it is toxic, but it is that the light sweet
crude is just very valuable because it bypasses these critical
units and so it has become much more important.
Now, I have read EPA's rulings and I have read the DOE
studies on what the low-sulfur diesel rules were going to do,
but nobody has gone back and asked the question, in fact, has
shifting to this essentially pure diesel fuel led to a
reduction in the rate of refinery operation rates and has that
contributed to the price increase. One of my good friends who
is a politician says it is not a question we want to ask
because the answer is not going to be helpful. But that is the
nature of the problem.
So to answer your question, we have SPR facilities that
have heavy sour crude and we have them that hold sweet crude. I
would sell off the sweet crude and fill them with sour crude.
In an emergency, if we really have to replace the crude, we can
relax the environmental standards the way we did in Hurricane
Katrina. I think there is a likely probability that we would be
dealing with a much lower price of crude.
Senator Coleman. Thank you. Thank you, Mr. Chairman.
Senator Levin. Thank you very much. Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman.
To follow up on this discussion about the sweet crude
versus the sour crude, recognizing that it is the sweet crude
that WTI looks to to set that price, and then the higher demand
for this sweeter crude, is there an alternative benchmark that
we could use, a suitable alternative to this sweet crude that
might make a difference one way or the other?
Mr. Verleger. Actually, I ought to plead guilty. I was at
Drexel Burnham that created the NYMEX crude contract in 1983,
and the reason they picked NYMEX at the time was there were a
number of suppliers and a larger number of buyers, and no
market control. Cushing was the perfect place. There is a
second one, Brent, that has been created. It is much harder
because you don't have as many producers or consumers.
It is certainly possible now--Mars, a sour crude produced
in the Gulf of Mexico, was not in production. There are other
fields with larger production. The ideal would be a Middle East
crude, but the Saudis have always refused to allow resale of
their crude or sale of the crude on the open market. This
essentially bars us from using something like that.
But yes, one could pick a crude. That chart,\1\ presented
by Senator Dorgan, showed the price of Saudi crude has not gone
up as much as the price of light crude. It could be done. We
didn't have financial settlements of futures contracts in 1983
as we do today. One could move to a financial settlement. One
could use the large volumes now of much more sour crude coming
south from Canada from the tar sands because there are a number
of producers and their pipelines are being built to bring them
down. So there are substitutes and you could move the market.
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\1\ See Exhibit No. 8, which appears in the Appendix on page 129.
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Senator Murkowski. It seems to me that since 1983, we have
seen a great deal of change. Mr. Gheit, do you want to comment
on that?
Mr. Gheit. Just to explain why WTI has moved up faster than
any other type of crude and didn't come down. One of the
reasons that you have unprecedented shutdown or unexpected
shutdown in refinery capacity over the last 7 or 8 months, or
even longer. Whiting in Indiana and Dixon City were shut down a
couple of years ago, and these refineries, their conversion
unit which is able to take heavy sour crude, convert it into
light product, which is really where that profit is, obviously
could not operate because of the fire and explosion and
everything else, so they had no other choice but to operate on
pure light sweet crude. So the demand for light sweet crude
obviously moved up very sharply. That is why you see the
differentiation between the oil coming from Canada and the WTI
increased almost $30, $40 per barrel over the last few weeks.
But the idea for us to increase the buying of light sweet
crude into the SPR also sends the wrong message to the world
and to the traders that we could be facing potential supply
disruption. We are just sending the wrong message to the world
market, saying that we are worried about the future
availability of crude oil. That is why we have 700 million
barrels of crude oil inventory, or SPR, but we want to increase
it even more.
So as I said, traders will take anything that they can get
their hands on to exploit the situation, to make profit, to
exaggerate the situation. A pipeline was shut down a couple of
weeks ago, and before you know it, obviously, the traders in
London spiked the price before we get into the office. I walked
into my office and all of a sudden, what happened overnight?
Well, there was an explosion. Everybody said there is going to
be $100 oil or whatever. The fact of the matter, it was
repaired in no time, but this is after the fact. They already
made the money. The whole idea is that they amplify the bad
news because----
Senator Murkowski. How much does the fear factor really
factor into the speculation, then?
Mr. Gheit. I personally believe that there is at least a
$30, $35 premium in oil prices as we speak. One of the reasons
is that nothing has changed in the physical supply and demand
since August of this year, yet oil prices moved up by almost 50
percent.
Senator Murkowski. It has gone----
Mr. Gheit. Yes. Everything else is equal. China is going.
We have winter, we have summer. We have driving, we have
seasons, we have everything. Nothing was new, in my view.
Everything else is equal, and all of a sudden, oil prices went
from $65 to almost $98. There was no justification for it.
Senator Murkowski. Thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator Murkowski.
I think I will, unless it makes a difference, I will go
back and forth now if that will be all right. Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman.
Mr. Caruso, you run the lead Federal agency for analyzing
information about energy prices and supply, and yet, as you
have in the past, which is why I started the discussion an hour
ago about you all, you have again told the Subcommittee that
speculation is not a serious problem and it doesn't warrant a
serious response. I disagree profoundly with it, and obviously
my colleagues do, as well. So let me get into a few of the
specific issues and have you tell me whether you think it is in
the public interest to know information about areas I think are
important.
With respect to physical inventory, and you all issue these
reports, you put them out, there are millions and millions of
barrels of oil sitting in storage now. Do you think it is
important for the public to know who the large holders are of
those barrels of oil?
Mr. Caruso. Yes, I think that is public information. I
mean, the owners of inventories are the big oil companies. We
don't publish them by company. That is confidential. But the
fact that those companies are----
Senator Wyden. That is what I am asking for. I think that
the public ought to have a right to know who the large holders
are. I don't know of anywhere where people can get that
information. Are you saying that there is somewhere where I can
get that information?
Mr. Caruso. We do not publish it because we----
Senator Wyden. But I asked you----
Mr. Caruso [continuing]. We collect it on a pledge of
confidentiality.
Senator Wyden. But do you think it is in the interest? Is
it in the public interest for our people to know who are the
large holders? I do, because I think it goes right to the heart
of being able to track speculative activity here. I mean, this
is not a question of price controls or somebody introducing
legislation. It is a question of information that I think
people ought to have. But you don't think it is something you
ought to be doing?
Mr. Caruso. We collected data on a pledge of
confidentiality, based on statutes that established the EIA in
1977, as other statistical agencies do.
Senator Wyden. Do you think you ought to make that
information available to the Congress, because you have
resisted----
Mr. Caruso. We will do whatever is the law.
Senator Wyden. You have resisted that in the past.
Mr. Caruso. We comply with the law. There is a law.
Senator Wyden. Do you think that ought to be done in the
future?
Mr. Caruso. I would leave that up to the policy makers----
Senator Wyden. But I am asking you because you are the
person who right now is on the front lines of collecting
information about speculative practices when people like Lee
Raymond are coming in here and telling us it is a very
significant factor. Do you think that kind of information ought
to be made available to the Congress so that the Congress can
make judgments in this area? Yes or no?
Mr. Caruso. From a statistical point of view, no, because
it would----
Senator Wyden. Thank you.
Mr. Caruso [continuing]. Stifle the data collection.
Senator Wyden. OK. Then let me ask you about the
relationship of CFTC to the role that I think you ought to be
performing, which is to be looking, for example, at large
holders in matters that go to speculation. Now, the CFTC has
issued a variety of announcements recently--a million dollar
settlement penalty against Marathon Oil, the settlement penalty
against a former British Petroleum gasoline trader, and
Amaranth. We are talking about a variety of these different
settlements. So what this all goes to is the manipulation of
the very prices your organization is insisting can be explained
by the laws of supply and demand. Why do you all think that you
should sort of ignore these documented examples of market
manipulation?
Mr. Caruso. We don't ignore them. We work in cooperation
with CFTC when those instances are required through the
procedures that are already in place.
Senator Wyden. Well, you don't collect large trader
information on who is holding physical energy inventory. I
mean, it seems to me you say, well, some other people are
taking action in this area, but you have got hundreds of people
and you can't put a few people on this particular issue of
looking at speculation?
Mr. Caruso. This is the role of the CFTC and the Federal
Trade Commission and others to provide oversight and
enforcement. We are a data collection and analysis agency. I
think the CFTC is doing its job.
Senator Wyden. I just think for you to say, in effect, that
it is not your job, even though you have come up to the
Congress and said it is really market forces. I mean, Senator
Levin asked you about that. I have asked you about it in the
past. You have got it in your reports. You say this is really
not a very serious thing. So you are making a conclusion, it is
not a serious thing, but you won't put anybody on the question
of actually analyzing what is going on in some areas like
finding out who the large holders are. And I think that is a
dereliction of what the lead Federal agency ought to be doing.
I am telling you, I am going to bird dog this until we
change your agency's role on this. I think you are a decent
fellow. We have talked about this in the past. But I think the
agency is profoundly wrong with respect to sitting on the
sidelines about speculation and I suspect, having listened to
colleagues here this morning, we are going to have some allies
as we try to get you all off----
Mr. Caruso. I just want to clarify. I am not saying it is
not a serious issue. It is a very serious issue.
Senator Wyden. Chairman Levin had to ask you at least three
times the question of whether you thought speculation was even
a factor. You haven't--and that is why I quoted the reports. Do
you want me to read them back to you? In 2006 and 2007, you
said that it was not a serious problem, and you have dismissed
it again. It is, and your agency is not doing what it ought to
be doing in terms of collecting this information. I, for one,
am going to stay at it until we get it.
Thank you, Mr. Chairman.
Senator Levin. Thank you. But you just said 20 seconds ago
it is a serious problem.
Mr. Caruso. No. I said we are not saying it is not a
serious issue.
Senator Levin. It is a serious issue.
Mr. Caruso. It is a serious issue that should be looked at
by the appropriate----
Senator Levin. It is the first time we have heard you use
the word ``serious'' relative to speculation, that is a serious
issue. As often as a number of people have tried to get you to
acknowledge that, you have been unwilling to say that.
Mr. Caruso. Well, it may have been the different ways the
question was worded. I am saying that the issue that is being
discussed here, looking at the role of speculation in the
market, is definitely a serious issue and I agree that it is
the appropriate thing to be looked at by the Commodity Futures
Trading Commission and others that are charged with oversight
and enforcement.
Senator Levin. But not by you?
Mr. Caruso. We look at it as one of the many factors in the
oil market analysis----
Senator Levin. Thank you.
Mr. Caruso. And that is the way I responded to your
question. It is one of many factors.
Senator Levin. Thanks. Senator Collins.
Senator Collins. Thank you.
Mr. Caruso, current law requires the Department of Energy
to evaluate the impact on markets when the SPR is being filled,
and as a result of an amendment which Senator Levin authored in
2005 and I was his chief cosponsor, the law specifically says
that decisions that the Department makes with regard to the
Strategic Petroleum Reserve must be made to ``avoid incurring
excessive cost or appreciably affecting the price of petroleum
products for consumers.'' So the law is very specific, yet you
have testified today that those in charge of filling the
reserve have not consulted with you on what the impact on
prices would be. Is that correct?
Mr. Caruso. That is correct. We have not been asked to
analyze the impact of----
Let me just correct that. I was asked in late 2003 and we
presented a memorandum to Secretary Abraham at that time.
Senator Collins. But as we have all pointed out, we have
had a huge jump in oil prices in the last 6 months and yet the
Department is continuing to fill the Strategic Petroleum
Reserve, thus taking oil off the market. So I am left at a loss
why you have not been asked by those responsible for making the
decisions on when and whether to fill the reserve to make those
purchases, that you have not been asked what the impact would
be on consumer prices, on supplies, on inventories as the law
specifically directs that to be taken into consideration. Do
you believe the Department of Energy is complying with the law?
Mr. Caruso. I would have to defer to, of course, the policy
makers in the Department, but they have other analytical
resources--such as the Office of Fossil Energy, which is where
the Strategic Petroleum Reserve exists----
Senator Collins. But you have described yourself this
morning as the agency that does data collection and analysis.
Aren't you the logical agency within the Department for those
making this decision to turn to?
Mr. Caruso. Senator, as I indicated, we are certainly
available to do what is required by the Administration or the
Congress.
Senator Collins. Well, back when Secretary Abraham was in
charge of the Department, you said you were asked what the
impact would be, correct?
Mr. Caruso. That was correct, in 2003, I believe.
Senator Collins. And you have not been asked since that
time, despite the fact that we have had a huge spike in oil
prices, which would suggest that it is the worst possible time
to be buying oil for the reserve, is that correct?
Mr. Caruso. I have not had any formal request to do that.
Senator Collins. Mr. Chairman, I hope this is an issue that
we can pursue, because it seems evident to me that the
Department is not complying with the law that you wrote and I
was pleased to be your principal cosponsor. The law is very
explicit on what the standards are, and yet it appears that the
Department is not even making the analysis necessary. So I look
forward to----
Senator Levin. In that regard, why don't we do this,
Senator Collins, and thank you for pointing this out. We are
going to ask you, Mr. Caruso, to ask the policy makers at the
Department of Energy why it is that they have not consulted
with you and whether or not they have complied with the
provision that Senator Collins has identified which is law, and
if not, why not, and report back to these two Subcommittees.
Will you do that?
Mr. Caruso. Yes, Senator.
Senator Levin. Thank you.
Senator Collins. May I ask one quick question?
Senator Levin. Yes.
Senator Collins. Dr. Verleger, I very much appreciated your
testimony on the Strategic Petroleum Reserve because I, too,
believe that was a factor that we can influence that has the
potential to affect prices. You say in your testimony that the
current oil price increase has not been spurred by speculation,
and I just want to make sure I am understanding your testimony.
It seems that you and Dr. Krapels have come to different
conclusions, is that correct?
Mr. Verleger. I am not exactly sure where Mr. Krapels is on
that. One of the problems, as the CFTC noted in its paper on
large trader activities, it is very easy to look at the same
data and reach two different conclusions.
What I have observed since August 18--I think I first
followed this data in an academic article in 1985--a couple of
things have happened. One is we have a financial crisis and as
part of that financial crisis, we have seen people look for any
sort of asset that is liquid that they can price, like the
Special Investment Vehicles (SIVs), and so on. So to a certain
extent, I think there has been downward pressure on prices. I
think we will learn later when we get the data there is
downward pressure on prices from speculators as financial
organizations scramble for liquidity. This is something that
Charles Kindleberger wrote about in ``Manics, Panics, and
Crises'' years ago and is something many of my classmates at
MIT have studied and I have been following.
As I said, we have had this very big price increase and
this is--speculation just doesn't fit with this right now
because the people who were long oil or were long physical
assets are desperate for cash and they are going to Treasury
bills. So I think in this cycle, this particular time, I don't
think we are going to find it is speculation that did it.
There are pension funds that are buying assets, and that is
what Dr. Krapels and I were talking about in Vienna, and those
pension funds have continued to buy assets. Harvard has bought
assets, and so on. They view those as a better return than,
say, buying Exxon stock, and it is perfectly legitimate. That
is not speculation. These are people who own stock and stay in
that asset for long periods of time. They may have to roll
their futures positions every month. They may choose to buy oil
and then just every month replace the futures contract. But
that is not speculation. That is investment and that is a new
form of speculation.
Senator Collins. Thank you. Dr. Krapels.
Mr. Krapels. I completely agree with Mr. Veleger. I don't
think we are in a different position here and I think the use
of the word speculation tends to narrow the discussion. When a
pension fund decides to buy a lot of oil contracts as an
ongoing strategic acquisition of assets and intends to hold
those contracts for years and years and just simply rolls them
over, is that speculation? It is, but it is not a speculative
organization that is doing it because it is likely representing
people that you wouldn't typically associate with speculation.
So one of the things I tried to share with you in my
written testimony is that there are four or five different
types of financial entities engaging in this market. It has
created a hyper-sensitive situation. If delta hedging is having
the effects that Mr. Velerger describes, then what we really
have here is just a hyper-sensitive market created by the very
size of the positions that hedgers and speculators constantly
deal with.
Senator Collins. Thank you. I think your final comments
show how difficult this issue is. I am convinced that we do
need better oversight, much more transparency. I think that is
absolutely key. And exactly how to draft this legislation, I
think is going to be a real challenge to us, and yet I think
something needs to be done. Thank you for your testimony. Thank
you, Mr. Chairman.
Mr. Krapels. Thank you.
Senator Levin. And we will have another round now of
questions.
Dr. Verleger, you indicated in this cycle, you didn't think
that speculation was the cause of the jump. In the previous
cycle, 1 year earlier, I believe you did feel that in that
cycle, as I remember, $20 of the $70 price of oil in that cycle
you felt could be attributed to speculation. You are not
saying, as I understand it, that it is not that speculation
doesn't impact prices, it is just that in this particular
cycle, you don't see that is the cause of this particular
increase?
Mr. Verleger. I would have to go back. I think one of the
things Mr. Krapels and I say is that when we first started
looking at this, we both had color in our hair. I think if you
read the history of agriculture and so on, speculation always
gets more credit than it deserves. I think at one point, $20
was done a couple years ago.
Senator Levin. Let us be clear. Twenty dollars was on a $70
barrel?
Mr. Verleger. When the price got up to $70, yes.
Senator Levin. That was your feeling at that time?
Mr. Verleger. That was the feeling at the time. I probably
wouldn't say it again today. I think if I looked at it, I would
come to a different conclusion.
Part of it is, as Dr. Krapels has just pointed out,
commodity--what we have had is a move into commodities as an
asset class. That started in 1990. I refer to a paper by two
Yale and Penn academics, but there have been a series of them,
and it took--very little money came for years and then a lot of
cash started coming in around 2004 and some of that got seen as
speculation. But essentially what it did was these firms would
buy oil, buy other commodities. It is a diversified portfolio
that they follow, and they follow a very rigid set of rules.
From 2004 to 2006, we benefited because that converted
backwardation to contango and that promoted inventory building,
so that a year ago, Morgan Stanley was holding a great deal of
heating oil in New York Harbor and earning a good return on
this. This is how Cargill became famous. They buy at $20 and
you sell forward in the futures market to $40 and earn a return
of, if that is a year, 100 percent. Those inventories were
available last winter and so they reduced the price of heating
oil in Maine and Minnesota and they reduced the price of crude
oil. The investors lost money because of the way they were
structuring their instruments and they have changed that. And I
think I picked up some of that was speculation.
Senator Levin. All right. Let me go back to you, Mr.
Caruso. In your Energy Information Administration report, which
I have quoted before, you said that the role of these non-
commercial future market participants in recent price
developments is ``difficult to assess.'' But then you say
general principles favor a focus on fundamentals rather than
consideration of alternative price drivers. You are saying that
the reason you are not assessing them is because it is
difficult.
Mr. Caruso. It is difficult to actually get at a specific--
--
Senator Levin. But now you are saying----
Mr. Caruso [continuing]. A specific number, let us say--you
just asked Mr. Veleger, $20 out of the $70.
Senator Levin. Right.
Mr. Caruso. What we are saying is that we do not believe it
is possible to actually pinpoint the dollar amount that is
related to speculation.
Senator Levin. But what troubles me is that here in this
report you are saying it is difficult to assess.
Mr. Caruso. Yes.
Senator Levin. Here, you are telling us it is someone
else's job to assess it, not yours. You said CFTC assesses it.
Mr. Caruso. No. I am saying that when one looks at what is
the impact of speculation on the marketplace, there are other--
--
Senator Levin. Of course. We all agree to that. It is not
the only factor. It is one of many factors.
Mr. Caruso. Yes.
Senator Levin. Since it has been such an increase, a huge
increase in speculation, we have asked you to assess it. Here
you are saying it is difficult in your report. Therefore, you
will look at more fundamental things.
Mr. Caruso. Yes. Our assessment----
Senator Levin. Yet you tell us today, well, someone else is
assessing it, CFTC.
Mr. Caruso. What I am saying is that our assessment is that
we can explain most of the price increase through fundamentals
and the other factors that are listed there. I won't go into
all the factors again.
Senator Levin. Right.
Mr. Caruso. But when one looks at whether manipulation is
the cause of the price increase----
Senator Levin. Let us try speculation.
Mr. Caruso. There are studies out there, such as by the
CFTC, the IMF, your own Committee, that we look at, and after
looking at all of the available evidence, our assessment is
that we can explain most of the price increase through the
fundamentals and the other geopolitical and political factors
that are listed there.
Senator Levin. Right, but we are interested in the part
that is not explainable that way and we are asking you to----
Mr. Caruso. We think it is very small.
Senator Levin [continuing]. To do your job.
Mr. Caruso. We think it is very small.
Senator Levin. To do your job.
Mr. Caruso. And we say----
Senator Levin. But I thought it was difficult to assess.
Now you are saying it is very small. It sounds like you have
assessed it.
Mr. Caruso. It is difficult to assess, and after doing our
assessment of the fundamentals, most of it can be explained by
those factors, those fundamental factors.
Senator Levin. Is it CFTC's job to analyze the causes of
oil price increases or decreases? Is that their job----
Mr. Caruso. No.
Senator Levin [continuing]. Or is it yours?
Mr. Caruso. No. That is our job, and I have given you our
best assessment of that.
Senator Levin. Your best assessment was that you pointed to
someone else's assessment. That is what you told us this
morning.
Mr. Caruso. No.
Senator Levin. I just want to get back to----
Mr. Caruso. That is not what I said this morning.
Senator Levin. OK. We will let the record speak for itself.
Mr. Gheit, you have heard Mr. Caruso here this morning. Do
you have any reaction to the Energy Information
Administration's position as to whether or not speculation is a
significant factor in the price increase or not and whether or
not they are pursuing carrying out their responsibility and
giving us an assessment?
Mr. Gheit. Well, what I heard is that it is very difficult
to estimate or assess, and then I also heard it is very little.
That means that there is a conclusion that it is not big
enough, so----
Senator Levin. That it is not very big?
Mr. Gheit. Yes. On one hand, we said it is very difficult
to assess. On the other hand, we are saying it is small. Either
it is difficult to assess and I don't know exactly what it is,
or it is very small and I did my homework and I can tell you
that it is small.
Senator Levin. And now when you have given us your opinion
this morning about this is a significant cause of the recent
major jump, 100 percent increase in the price of oil, are there
studies that you point to, or is that based on experience?
Mr. Gheit. It is, as I said before, I have been in this
business 30 years. I have seen cycles and this is another
cycle. This is an oil bubble. It is a classic case of oil
bubble. You talk to people in OPEC, they cannot explain it. You
talk to people in the industry, they cannot explain it. The
speculators know the number of contracts outstanding. When
people say oil prices are going to go up this Friday because of
the expiration date, that has nothing to do with supply and
demand fundamentals. That is the flow of paper coming into
somebody's desk and just pushing a button and saying, buy me
more or buy me less. So it has nothing to do--basically, we
have a disconnection between the physical market and the
financial market.
Senator Levin. OK. Let me call on Senator Murkowski and I
will come back. Thank you. Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman.
I think if I listen or try to read between the lines here
that everyone is at least in agreement that when you have tight
supplies, it can lead to speculation, which can ultimately lead
to the manipulation that we are all concerned about here. So I
want to talk just a minute about the supply, the inventory
aspect, and Mr. Caruso, you mentioned in your testimony, you
stated that OPEC has altered the targets over the years. Do you
think that OPEC has purposely created an inventory tightness
and continues to keep its production at levels that deprive the
markets of our ability to build inventories?
Mr. Caruso. I think it was definitely their goal when they
reduced quotas late in 2006 and the beginning of 2007. There
were two reductions of OPEC targeted production levels, in the
fall of 2006 and another one in the early part of 2007, mainly
because they saw that inventories in the United States and
other OECD countries were relatively high relative to the 5-
year average and they saw prices coming down. In the latter
part of 2006 and the beginning of 2007, prices had gotten into
the $50 to $60 range. This clearly was, in OPEC's view, a price
that they would like to have seen increased, and that is why
they reduced production. From the period of the fourth quarter
of 2006 through the third quarter of 2007, OPEC production was
reduced by about 800,000 barrels a day, leading to lower
inventories and a tight, very tight market leading, we believe,
to most of the price increase.
Senator Murkowski. In the aftermath of Hurricane Katrina,
we know that there were refineries that were offline and we
know that there were wells in production that were taken off at
that time. Are we at 100 percent now after Hurricane Katrina in
terms of those wells that were producing prior to? Are we
missing anything domestically then in terms of our ability to
produce domestically?
Mr. Caruso. Well, the oil and gas production in the Gulf of
Mexico is increasing, but it is still below the level that
would have been expected had the major hurricanes not occurred.
Senator Murkowski. But is everything online?
Mr. Caruso. We are a bit below. Some decisions were made
not to bring certain wells and other facilities back online
because the cost was believed to have been prohibitive given
the revenues that could be earned by bringing that back online.
The cost-benefit decision was made to leave some of that
production offline and it delayed the new production in some
fields, including Thunderhorse, which, of course, was damaged
by the hurricane directly.
Senator Murkowski. But in terms of significant amounts,
would you describe that as being significant to what we are
seeing in our inventories now?
Mr. Caruso. I would say it was important, but clearly not
nearly a major driver--about one to two hundred thousand
barrels per day lower than it would have been.
Senator Murkowski. Let me ask you a little bit different
tact here. This was in your written testimony and you also
mentioned briefly in your oral testimony here the impact of the
U.S. dollar, recognizing that we are seeing a decline there,
adding to continued oil consumption because oil is trading in
U.S. dollars, making the increase in the price of oil less
severe on foreign economies. Is it likely that oil prices might
move from dollar pricing to being based on some other currency?
I know that this was discussed in some recent OPEC meetings.
You look at European nations, you look at Japan with very
strong currencies of their own. Is that price of oil affecting
them as we are seeing here? Just give me a little discussion on
whether or not we will continue the direction that we are
currently on in terms of the oil pricing.
Mr. Caruso. The appreciation of other currencies relative
to the dollar has meant that the costs to consumers in the Euro
zone, in the yen in Japan and even in some other currencies,
the full cost of the price increase is not being borne by the
consumers in those areas. Therefore, it has contributed
somewhat to an increase in demand because it is a lower real
price. It has also contributed to, I believe, thinking in the
discussions and the OPEC meetings that have been reported--that
OPEC ministers have said their revenues, in effect, are buying
less because of the purchasing power loss--and so it is
certainly possible that is part of the decisionmaking process
within OPEC, as well. Whether it would lead to a change in the
way oil is priced, I continue to believe that it will not
because so many of the assets held by OPEC countries are in
dollar-denominated assets that it would be detrimental to their
own assets.
Senator Murkowski. Does anybody else disagree?
Mr. Gheit. But also in OPEC, some of the countries have
their own currency pegged to the dollar, and therefore when
they have the revenue come in dollars and then they have to pay
their costs with their foreign workers coming from Korea and
elsewhere, these workers now are demanding to be paid either in
Euro or their own country currency because the money they are
sending home is really less than before because of the
depreciation of the U.S. dollar. So there is tremendous
pressure on OPEC.
I was in Dusseldorf last week and there was a TV interview
with the Chilean oil minister who said that I wish we had known
about the drop in the dollar. We would have thought about
switching to another currency before the fact. But obviously,
if you plot the dollar against the Euro, for example, it is
down almost 40 percent in the last couple of years here. So you
are going to see additional pressure, upward pressure on the
oil price as a result of the decline in the U.S. dollar.
Senator Murkowski. Thank you, Mr. Chairman. I have no more
questions.
Senator Levin. Thank you. Let me get back to the NYMEX
contract for a minute. We were talking, Senator Murkowski and
others were talking about valid benchmarks and the benchmark
which is used for the NYMEX price is the Cushing, Oklahoma
price. Now, that price can be affected, I take it, when we are
using sweet crude for the SPR. Dr. Verleger, that is basically
the heart of your testimony, is it not?
Mr. Verleger. Yes. Now, when they say the NYMEX contract is
the West Texas sweet crude, it is actually light sweet crude.
Senator Levin. Light sweet crude.
Mr. Verleger. There are a number of crude oils that can be
delivered against the NYMEX contract and the list has changed
over the years with the NYMEX to expand the deliverable. For
example, a Brent could be delivered into Houston and then piped
up. It has to be moved into Cushing unless an alternative
delivery procedure is agreed to by both the long and the short.
But there are a number of crudes and they are all kind of light
sweet. Many of them are also on the list of sweet crudes that
qualify for submission to the DOE's West Hackberry, where they
keep sweet crude in the Strategic Petroleum Reserve.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 20a., which appears in the Appendix on page
208.
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Senator Levin. Would it be wise for the SPR to use a
greater percentage of non-sweet, I guess sour crude, in terms
of price?
Mr. Verleger. That is in my testimony. Yes.
Senator Levin. That is the heart of your testimony?
Mr. Verleger. Yes, the heart of my testimony.
Senator Levin. All right. Now, Mr. Caruso, why is the DOE
not doing that?
Mr. Caruso. My understanding, as I am not in the policy
making business, but my understanding is the way the crudes are
chosen is to try to have the best mix that fits our refinery
configurations in this country and that is what the Strategic
Petroleum Reserve Office has used as a criteria for that.
Senator Levin. All right. So now Dr. Verleger----
Mr. Verleger. I was at Treasury when we created this in the
1970s. In the 1970s, we had a number of refineries that could
only process sweet crude and so they developed a number of
facilities. If you read the international energy programs,
there are a number of different storage salt domes and we put
sweet crude in those and that is 30 years ago.
Now, we have moved to a situation where more refiners can
process heavier crudes. We also have gone to these very tight
environmental specifications which could in an emergency be
relaxed, as they were after Hurricane Katrina. And yet to my
knowledge, there has been no study as to whether the mix of
crudes we are putting into the reserve today is appropriate
given today's refining standards.
Senator Levin. Or the capability of taking action if they
are not perfectly reflective of refineries, then.
Mr. Verleger. Right. Yes.
Senator Levin. Either one.
Mr. Verleger. Yes. This is----
Senator Levin. Mr. Caruso, why doesn't the DOE make that
change to save American consumers some money?
Mr. Caruso. I am not aware why they have not. I do know
that the current mix of fill is one-third light sweet and two-
thirds heavy sour.
Senator Levin. We set in law, we know that, but that is
apparently the way it has been for some time. Has it changed
that mix?
Mr. Verleger. Well, next June, the material the
Subcommittee staff provided me said that it is going to be two-
thirds sweet crude, one-third sour crude in the first half of
this next year.
Senator Levin. Now, why is that being done?
Mr. Caruso. I would have to answer that for the record
because it is a decision made by the office within DOE that
runs the Strategic Petroleum Reserve.
Senator Levin. Yes. Would you find that out?
Mr. Caruso. Yes, sir, I will be happy to.
Senator Levin. We have been pressing this point. We have a
law which says that you have got to fill the reserve in a way
that minimizes the cost. It looks to me like the DOE is
ignoring the law, as Senator Collins pointed out, but also
ignoring the pocketbook of Americans. This is a reserve. This
isn't oil that we are going to have to refine. It is oil that
someday we may have to refine, and we may have to waive
environmental laws to refine it. But if an emergency is such
that we have to take oil out of the reserve, why would the DOE
ignore the law, but ignore the pocketbooks of Americans?
Mr. Caruso. I will take that question back to the
Department, Senator.\1\
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\1\ See Exhibit No. 20b., which appears in the Appendix on page
209.
---------------------------------------------------------------------------
Senator Levin. There is a chart that is up there.\2\ This
is the price of oil at Cushing and this shows the relationship,
at least at Cushing, of supply and demand, and we show here
that when the demand goes up and when the supply goes down, the
price goes up. It relates inventories to price. Mr. Caruso, can
you see that chart?
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\2\ See Exhibit No. 4, which appears in the Appendix on page 121.
---------------------------------------------------------------------------
Mr. Caruso. Yes, sir.
Senator Levin. Does it make sense for us to be decreasing
the supply at Cushing of sweet crude by putting that sweet
crude in the SPR when the direct effect of what we are doing is
increasing the price at Cushing, Oklahoma, which has a direct
impact on the NYMEX price, which has a direct impact on future
contracts? Does that make sense to you, or do you disagree with
that?
Mr. Caruso. Well, the facts are the facts. I mean, those
are the facts that are on the chart. I don't disagree with the
facts of the----
Senator Levin. You believe that supply and demand is the
thing that is the most controlling in terms of the cost of oil.
We have argued this morning about ignoring the impact of
speculation. But here at one location where there is not
speculation, there is direct supply and direct demand, we see
the relationship of price to supply. You are a big believer in
that as being the cause instead of speculation in the general
market. Why in the name of heaven would the DOE not follow the
law to reduce that cost to Americans? Why would it want to
increase the price of oil at Cushing, Oklahoma?
I know you are going to take it for the record. You are an
expert at this. You make assessments of energy prices. Can you
give us any idea from your perspective why they would do that?
Mr. Caruso. Well, obviously, a decision was made based on a
number of factors----
Senator Levin. But why would that decision be made? Do you
know? Do you have any idea?
Mr. Caruso. I can't answer that question.
Senator Levin. We will get off that. Senator Murkowski.
Senator Murkowski. Go ahead, Mr. Chairman. I am finished
with my questions.
Senator Levin. OK. All right. Should we, and I can ask all
of you or most of you this question, should we encourage the
NYMEX--which does a terrific job, I think most people concede--
should we encourage them to broaden what their benchmark is?
This is something also Senator Murkowski asked. Should we
encourage them to not just look at Cushing, Oklahoma, but
broaden it? I guess the main determiner of that price, which
has got such a huge impact on the future contract prices, is
Cushing, Oklahoma. Dr. Krapels, let me start with you.
Mr. Krapels. Creating a successful futures market is really
difficult, and I think they have tried again and again and
again to create a benchmark sour crude contract and have
failed. There is simply that alchemy that they have somehow got
the WTI to get working in the 1980s has never repeated itself
in any other crude contract other than Brent, which looks like
and smells like WTI.
I am not sure Mr. Veleger would agree with this, but there
has recently been an effort to create a sour crude futures
market in the Middle East. I don't think it is going to
succeed. The reasons for it, we would probably need a whole new
set of hearings to discuss it. It is extremely difficult to
create a successful futures market.
Senator Levin. A different benchmark.
Mr. Verleger. I agree.
Senator Levin. All right.
Mr. Verleger. But part of it is a delivery location.
Futures markets work best when you have a number of producers
and a number of consumers and there is really no choke point,
and Cushing is unique in that it is where a number of pipelines
come together and there were a number of storage companies, and
since NYMEX has been there, they have built more tanks.
I think that there is some hope as pipeline reversals are
finished and sour crudes are coming down from Canada, one may
be able to move it, move and create a contract tied to the
Alberta contracts. The big problem, though, is that you have so
much financial interest now tied. You now have over 2 million
NYMEX plus ICE look-alike contracts, and that is just momentum
and that is just--one of the things they will tell you if you
are marketing futures contracts is the first exchange to be
successful wins.
Senator Levin. Would it be possible to broaden the delivery
points? Isn't that what you were suggesting?
Mr. Verleger. I was going to change the kind of crude----
Senator Levin. Well, we can't change the crude.
Mr. Verleger. Well, no, if you deliver south so you could
change it to a sour contract in Cushing, which would change
things. There are a number of delivery points available on
this.
The other thing is to go to a cash-settled contract. Brent
is cash settled with no delivery point, and it wouldn't have
worked in 1983 because no one believed energy was a commodity.
Now, that is not a problem, so you could go to a cash-settled
contract off of a series of indices and that would work very
well and that would take some of the distortions that were
identified here out.
Senator Levin. Let me go back to you, Dr. Gheit. You make
reference in your testimony to raising the current margin
requirement. What is the current margin requirement for these
contracts?
Mr. Gheit. It is all over the lot. The trends are about 8
to 12 percent.
Senator Levin. Eight to 12 percent?
Mr. Gheit. Right.
Senator Levin. And what is the margin requirement for stock
that the SEC has set?
Mr. Gheit. Fifty percent.
Senator Levin. Fifty percent for stock?
Mr. Gheit. Right.
Senator Levin. This is 8 to 12 percent here.
Mr. Gheit. Correct.
Senator Levin. Does that affect the amount of speculation?
Mr. Gheit. Absolutely. What we are trying to do here is to
slow down the traffic and to put a speed limit, because we
don't want people to get hurt. We are not saying that we should
block the traffic. We should allow it to proceed, but in a safe
manner----
Senator Levin. Now, the stock market has a lot of traffic,
does it not?
Mr. Gheit. Absolutely.
Senator Levin. Even though it has got a margin requirement.
Mr. Gheit. Absolutely.
Senator Levin. So we don't want to--we obviously want to
have some traffic, as you say, Mr. Gheit. Would you have a
problem, Dr. Krapels, with increasing the margin requirements?
Mr. Krapels. I would not. I think it is an overdue idea.
Senator Levin. Could you comment on that?
Mr. Krapels. Well, I think for exactly the reasons Mr.
Gheit has mentioned. We tend to get over-leveraged in these
markets. Big traders, especially speculative hedge funds, using
the amount of leverage that they use, it magnifies their impact
on price. I am not sure 50 percent is the right number, but
something well north of where we are right now seems to me like
good public policy.
Senator Levin. Anyone else?
Mr. Verleger. It seems to me that both Mr. Krapels and Mr.
Gheit are right. The one point to add is that all these passive
investors that are coming in that have bought into this market
essential have a 100 percent margin because they set aside,
when they buy a commodity contract, they set aside. So the
liquidity is there in the market already, and I think in terms
of reducing speculation, there is a longstanding history in
financial markets where you raise the margins and you reduce
the speculation. Whether it changes the behavior of prices, I
am not sure.
Senator Levin. OK.
Mr. Gheit. But also if we change, if the dynamics were to
switch into other types of crude, I do believe that will have a
negative impact on WTI and will just pull it down sharply. We
need to burst the bubble. Whether it is going to come from
economic slowdown or government action, but I feel that this is
like 24/7 open gambling hole that people are saying that nobody
will get hurt, but with the subprime, that with the S&L and all
these things, a lot of people were saying it is going to be a
win/win. There will be no casualties here.
The fact of the matter, it is different and I don't believe
that this party will last forever. It will come to an end, and
I think the sooner the better, because the longer it stays, it
is really going to distort and disrupt future capital spending,
because right now, a lot of oil companies will end up throwing
in the towel, believing that oil prices of $100 are here to
stay, and they will make investment decisions that we will
regret sooner or later. And that is obviously going to hurt the
oil industry. It is going to hurt the supply-demand situation.
So speculators are making money, but at a huge cost in the
future to the economy, to the oil industry, to everybody. So a
few people will make a lot of money at the expense of a very
large number of people.
Senator Levin. Many Members of this panel believe in that
very deeply, not all of us perhaps. I can't speak for anybody
else, but it is obvious that many of us think that this
speculation has run wild. The chart on the amount of
speculation demonstrates it.\1\ I think you all either think
that speculation has an impact on prices, obviously, or
clearly, or in the case of Mr. Caruso, a begrudging perhaps.
But nonetheless, that has been the subject of this hearing
today and----
---------------------------------------------------------------------------
\1\ See Exhibit No. 3, which appears in the Appendix on page 120.
---------------------------------------------------------------------------
Senator Murkowski. Mr. Chairman, can I----
Senator Levin. Please. Senator Murkowski.
Senator Murkowski. Before we wrap up, I am trying to get a
better handle in my mind on how we define what a speculator is.
You have a speculator that can affect prices and then you have
a speculator that can manipulate prices. Tell me how we
determine the difference, because I think it was you, Mr.
Gheit, or maybe it was Dr. Krapels mentioned when we were
talking about the pension funds and if you hold these for 20
years, is it speculation? Well, yes it is, but for a different
purpose than one whose intent is to manipulate the markets. And
I think this is where so many of my colleagues get so upset and
pound the table and say, we need to do something about it, when
we are actually manipulating the market. How do we define or
make that distinction?
Mr. Gheit. It is a very gray area. The speculation and
manipulation go hand in hand. You are not going to get an oil
trader coming on television saying that he thinks oil prices
will go down. Why? They are intimate. Everybody is in it now.
It is like if you can't beat them, join them. And it is almost
a self-fulfilling prophecy. When somebody says oil prices will
be $100 before the year end, everybody is pushing for oil
prices to cross the $100 mark.
Senator Murkowski. So are there any good speculators?
Mr. Krapels. There are many good speculators, and I think
you have asked a pivotal question, Senator. I don't think you
need to answer it. I think the one weakness of the report on
Amaranth is that it is titled ``Excessive Speculation.'' Now,
there is a clear case for excessive speculation in the case of
Amaranth, but it is so much on the margin of common practice
that I think the solution to the problem that we are talking
about, excessive volatility, tremendous hyper-sensitivity to
prices, could be substantially addressed with higher margin
requirements and much more information disclosure. If people
knew what was going on, we wouldn't have the conspiracy
theories that we have running around today. So a lot can be
fixed just with those two elements of the law--of the
proposals.
Senator Levin. Let me give the definition from the CFTC,
and I happen to agree with what you have said about
difficulties of defining, but this is what the effort is by the
CFTC. A speculator does not produce or use the commodity, but
risks his or her own capital trading futures in that commodity
in the hopes of making a profit on price changes. So I think
the key to it is someone who isn't producing or using a
commodity, but it is somebody who is buying and selling a piece
of paper with no intent to use or produce it, is that----
Mr. Krapels. But millions of our citizens do it, so----
Senator Levin. Of course. No.
Mr. Verleger. There is no difference, really, between my
purchase of General Motors stock, because I don't intend to use
or make General Motors products----
Senator Levin. But you do intend to keep it, the stock,
presumably, unless you are----
Mr. Verleger. But I also have a passive investment through
a fund in futures and they hold oil. Now, some of them hold oil
in the ground and some just buy futures and they just hold
claims on oil. It is a perfectly legitimate academic, or
financial definition. They buy the oil and they just hold the
position and then it matures, they sell the position because
they have to and they take another long position. They stay
steadily there. It is an investment. It is serving a very
useful purpose because it promotes investment, and it doesn't
cause this volatility.
Senator Levin. Let me ask a couple other of you about a
couple other suggestions here of Mr. Gheit. Current margin
requirements, you commented on that. Setting limits on the
number of oil contracts by each account is another one of the
suggestions at the end of your testimony, Mr. Gheit. Dr.
Krapels.
Mr. Krapels. I absolutely agree. I think looking at not
just the prompt month but the out months, as well, where
Amaranth did a lot of its mischief. I think looking at the
positions of individual traders as the CFTC does today,
applying that to ICE and monitoring it and enforcing rules is
part of what----
Senator Levin. OK, and Dr. Verleger?
Mr. Verleger. Absolutely.
Senator Levin. All right. So we have a third suggestion.
Now, establishing a minimum holding period. Mr. Gheit suggested
a minimum. This gets to the question of the teachers' pension
funds or something. They intend to hold that for a while.
Mr. Verleger. They hold it. They roll the positions
forward----
Senator Levin. But the fund that they are investing in
doesn't intend to hold it for a particular period of time. They
could buy and sell tomorrow or the next day constantly. But
does that have as much appeal to either of you as it does to
Mr. Gheit?
Mr. Verleger. The Goldman Sachs and the Dow Jones and these
other funds actually continue holding it. Based on the number
of dollars, they hold that number of contracts and they keep on
holding it. The holding period, when I heard Mr. Gheit say it
the first time, I said, that is a good idea. The problem is
that somebody who is speculating could take other offsetting
positions. I think that is a regulation that is probably
impossible to enforce.
Senator Levin. OK. Dr. Krapels.
Mr. Krapels. I agree.
Senator Levin. Now, preventing conflict of interest by
financial institutions is another of Mr. Gheit's suggestions.
Give us an example, if you would, of----
Mr. Gheit. Well, basically have the dozen or so largest
investment banks in the world, they are all involved heavily in
oil trading. But they are also clearinghouses. They also make
investments in their own account. So basically, they can see
your cards, you don't see theirs, so they can see the traffic,
whether it is going north or south, and they can put their
money either with or ahead of the people who are putting orders
through and they can manipulate the price the way they want to
see it.
Senator Levin. With their own holdings?
Mr. Gheit. With their own holdings, because they have a
position. They can basically move the market their way if they
want, and then it is in momentum and all of a sudden you see
everybody doing the same. Their program changes. They are all
the same.
But what I have noticed looking at what is happening, you
read a statement in London and all of a sudden you see the
reaction here in New York. It is almost fanning the flames. And
again, a self-fulfilling prophecy. You say oil prices--one
large investment bank not long ago said although we still think
oil prices are still going to go higher, but we advise some of
you might wish to take money off the table. Guess what? Oil
prices dropped by $4 in 1 day. There was no change in supply
and demand. The following day, oil prices regained the entire
amount.
Senator Levin. OK. Dr. Krapels.
Mr. Krapels. No, I don't like that idea.
Senator Levin. OK.
Mr. Verleger. I don't like it. I think it is impractical--
--
Senator Levin. On the conflict of interest issue?
Mr. Verleger. Conflict of interest, yes. It is--not given
the structure of our financial markets today.
Senator Levin. Can't do it, OK. The other one, stiff
penalties on violators----
Mr. Krapels. Yes.
Senator Levin. I will leave that one go.
Thank you all. You have been a terrific panel. We
appreciate it all. This has been a long hearing and we will
stand adjourned.
[Whereupon, at 1 p.m., the Subcommittees were adjourned.]
A P P E N D I X
----------
OPENING STATEMENT OF SENATOR JEFF BINGAMAN
I want to begin by thanking the witnesses, as well as Senators
Levin and Dorgan for chairing today's joint subcommittee hearing.
Today's session promises lively discussion on a topic we have been
debating in Congress for a number of years now: whether increased
speculation in financial energy markets is contributing to recent,
record-setting oil prices.
Certainly, there is a broad recognition that--in the long-term--
rising demand in developing economies such as China and India pose a
challenge. Political uncertainties in oil producing regions of the
world provide another source of grave concern.
But in addition to these factors, there have been a number of
important developments in financial energy markets in recent years.
These trends include a dramatic increase in the volume of trading in
oil derivative markets, and the participation of new classes of traders
in those markets.
According to a Government Accountability Office (GAO) report issued
in October of this year, the average daily contract volume for crude
oil traded on the New York Mercantile Exchange (NYMEX) increased by 90
percent between 2001 and 2006. Additionally, GAO noted that the average
daily number of noncommercial participants in crude oil markets--
including hedge funds and large institutional investors--more than
doubled from 2003 to 2006.
Finally, there has also been an increasing amount of trading
occurring outside of futures exchanges--characterized by former Federal
Reserve Chairman Allen Greenspan (in testimony last year before the
Senate Foreign Relations Committee) as ``a major upsurge in over-the-
counter trading of oil futures and other commodity derivatives.''
Taken together, it seems to me that just as the demand for physical
barrels of oil has grown with the global economy, there is an
increasing demand for oil purely as a financial asset.
Untangling whether and how these dual sources of demand may be
operating in concert--and potentially impacting oil prices--is
certainly a complicated task. To my mind, it is a task made more
difficult to the extent policymakers are confronted with a lack of
reliable or comprehensive data across these markets.
As it relates to the fundamentals of the physical market, this
includes a notable lack of reliable information with respect to global
oil reserves. As for trading in oil and other energy-related
derivatives, I remain troubled by the lack of transparency related to
the over-the-counter markets.
It seems to me that markets operate best on the basis of complete
and reliable information. In the absence of such information, I would
suggest that the probability increases for prevailing market prices to
become untethered from their fundamentals.
Today, we have a distinguished panel with us, and I think this
hearing offers us an opportunity to more fully consider a number of
these complicated issues. So again, I thank Senator Levin and Senator
Dorgan, and look forward to the testimony of our witnesses.
__________
OPENING STATEMENT OF SENATOR KEN SALAZAR
Thank you Chairman Dorgan and Chairman Levin as well as Ranking
Members Murkowski and Coleman for holding today's joint hearing on
crude oil markets. Today's hearing should shed light on the economic
and market forces that determine the price of oil. Global demand for
this resource grows stronger daily. Ensuring a rational and open crude
oil market is a matter of national and economic security.
The Enron scandal provided us with an object lesson in the
manipulation of electronic commodity exchanges, and I am sure that each
member of our two Committees takes that lesson to heart.
As oil nearly hit $100 a barrel recently, some analysts suggested
that speculation in the crude oil market played a role in this price
surge. Energy derivatives have become extremely popular as a financial
tool, and have attracted numerous non-commercial entities into the
crude oil market. Today we seek your views on whether these changes
have made the market more vulnerable to manipulation.
Because of strong leadership from this Congress, our country is on
the verge of a clean energy revolution. Our nation is extremely rich in
renewable energy resources and I am hopeful that we will one day
achieve true energy independence.
However, as we continue to rely on foreign oil in our
transportation sector, it is imperative for us to understand the
constraints we face in the marketplace. For this reason, I am pleased
that this hearing was organized and I look forward to hearing the
insight that our witnesses will share with us here today.
Thank you.
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