Senator Feinstein Offers Amendment
To Regulate Energy Trading
March 8, 2002

Washington, DC - In the wake of the Enron bankruptcy and the California energy crisis, U.S. Senator Dianne Feinstein (D-Calif.) today offered an amendment to regulate and provide transparency to all energy transactions. The amendment has bipartisan support and is being considered as part of the debate on the energy bill now in front of the Senate

"This amendment ensures that electronic exchanges that trade energy derivatives be subject to the same requirements as other exchanges, like the Chicago Mercantile Exchange, the New York Mercantile Exchange and the Chicago Board of Trade," Senator Feinstein said. "Furthermore, those who trade energy derivatives off an exchange would be required to keep a record of their transactions. That way, if there is a complaint, the federal regulators would have a record to review."

The bill would provide regulatory oversight to the Commodity Futures Trading Commission (CFTC) over all derivative transactions (transactions where there is generally no delivery) of energy commodities and ensure that all energy transactions are transparent.

The Federal Energy Regulatory Commission (FERC) retains authority over all energy deliveries. All energy transactions not regualted by FERC would be regulated by the CFTC.

Specifically, the amendment:

1) Repeals exemptions and exclusion for bilateral derivatives and multi-lateral electronic markets in energy commodities. All would again be subject to direct CFTC oversight;

2) Ensures that energy dealers in derivatives markets cannot avoid full price transparency and escape regulatory oversight.

3) Subjects all multilateral markets and dealer markets in energy commodities to registration, transparency, disclosure and reporting obligations. All energy transactions not regulated by FERC would be regulated by the CFTC.

4) Ensures that entities running on-line trading forums must maintain sufficient capital to carry out their operations and maintain open books and records for investigation and enforcement purposes.

The amendment is cosponsored by Senators Maria Cantwell (D-WA), Peter Fitzgerald (R-IL), Ron Wyden (D-OR), Barbara Boxer (D-Calif.), and Patrick Leahy (D-VT) Richard Durbin (D-IL), John Corzine (D-NJ).

The following is the text of Senator Feinstein's statement:

"What this amendment says is that electronic exchanges which trade energy derivatives, are subject to the same requirements as other exchanges like the Chicago Mercantile Exchange, the New York Mercantile Exchange and the Chicago Board of Trade," Senator Feinstein said. "Additionally, it says that if you are trading energy derivatives off an exchange you simply need to keep a record of that transaction and if it turns out that there is a complaint, the CFTC will have a record to review.

Presently, energy transactions are regulated by the Federal Energy Regulatory Commission (FERC) when there is actual delivery of the energy commodity.

Let me give you an example. If I buy natural gas from you, Mr. President, and you deliver that natural gas to me, FERC has the authority to ensure that this transaction is transparent and reasonably priced. However, energy transactions have gotten so complex over just the past decade so most energy transactions no longer result in delivery and thus, a giant loophole has opened where there is no oversight.

Let me explain. Mr. President, I can purchase from you a promise that you will deliver natural gas to me at some point in the future; this is referred to as a derivatives contract. Now I may never really need to physically own that gas so I can sell that gas to someone at a small profit, who can then turn around and sell it to yet someone else, and so on and so forth.

This promise of a gas delivery can literally change hands dozens of times before the commodity is ever delivered. Even then it may never get delivered if the spot market price is lower than the future price that comes due on that day.

In fact about 90% of energy trades represent purely financial transactions not regulated by either FERC or the CFTC. As long as there is no delivery, there is no price transparency. So we don't know the price or terms for 90% of the energy transactions. Again, this lack of transparency and oversight only applies to energy. It does not apply if you are selling wheat or pork bellies or any other physical commodity.

So as I said, there is a very big loophole here. Now why is this type of trading so important? Many of these transactions provide needed insurance so a company can lock in set prices in the future without necessarily ever having to receive delivery. For example, knowing the price of natural gas in the future allows an energy company to in turn, contract out its electricity since it will know the price of natural gas, the main cost of production. These transactions are here to stay. What my amendment simply does is shed light on them. Futures transactions do affect market prices for consumers and that is why we need this transparency.

And that is precisely why other commodities (except for excluded financial commodities) are already regulated by the CFTC. One simple example of how energy derivatives can affect delivered energy prices consider is the long-term electricity contracts that California and other Western states entered into last year which were priced according to the long-term future costs for natural gas.

As soon as the future price of natural gas plummeted (after the contracts had been signed), electricity prices fell substantially. All of a sudden these states looked foolish for signing these contracts.

Why has this come up all of a sudden? The simple answer is that the Commodity Futures Modernization Act signed into law in 2000 exempted energy and minerals trading from regulatory oversight and also exempted electronic trading platforms from oversight.

So in a sense, what that legislation did was set up two different systems treating electronic trading platforms different from other platforms and treating energy commodities different from other commodities. Up until 2000, energy derivative transactions were regulated just like other transactions. And electronic trading platforms were treated like other platforms. I repeat, these are the standards that were in place all the way up until 2000. Up until that time if a gas or electricity commodity was delivered, FERC had oversight, if there wasn't delivery, the CFTC had the authority.

So the loophole arose just two years ago. At the time of the 2000 legislation, nobody knew how the exemptions would affect the energy market. We have a much better idea today because of what we have learned since then. It did not take long for Enron Online, and others in the energy sector, to take advantage of this new freedom by trading energy derivatives absent any regulatory oversight or transparency.

Thus, after the 2000 legislation was enacted, Enron OnLine began to trade energy derivatives bilaterally (over the counter in a one-to-one transaction) without being subject to any regulatory oversight whatsoever. It should not surprise anyone that without the transparency the prices went straight up. Enron OnLine profited handsomely from both the volatility and the higher prices it could cause through these transactions.

Let me give you an example of how that lack of transparency and oversight affected California: On December 12, 2000, the price of natural gas in Southern California on the spot market was $59 a decatherm while it was $10 a decatherm in nearby San Juan, New Mexico. (A decatherm is a thousand cubic feet or enough gas to power about 100 Kilowatt hours of electricity for a typical power plant. It is enough gas to provide electricity for about 900 homes for one hour.)

This problem lasted from November, 2000, to the end of April, 2001 -- a full six months -- while energy price spikes affected the entire western energy market. And all this time hardly anyone understood what was happening in non-delivered energy transactions. At the same time California's electricity prices went from $7 billion in 1999 to $27 billion in 2000 and $26.7 billion in 2002.

So you can see that there are serious ramifications when markets cannot work. The Senate Energy Committee examined this issue last year but was not able to piece together all of what happened. In the wake of Enron's bankruptcy, however, we are beginning to learn a lot more. By controlling a significant number of energy transactions affecting California and by trading in secret, Enron had the unique ability to manipulate prices and gouge customers.

And the consumers, particularly those in California, ultimately bore the brunt of the costs.

So let me explain how this amendment works:

First, the bill repeals the provisions of the 2000 Commodity Futures Modernization Act (CFMA) which exempted energy derivatives from regulatory oversight. As I said before, these transactions were regulated by the CFTC until 2000, so this is not an entirely new authority for the CFTC.

As a result of this provision, all electronic trading exchanges will once again be subjected to the same oversight as other exchanges when it comes to energy transactions. Companies trading energy commodities "off the exchange" will simply have to keep a record of that transaction. Just as they do for other traded commodities.

The amendment also requires FERC and the CFTC to work together to ensure that energy trading markets are: 1) transparent, 2) regulated, and 3) working. This will close the regulatory loopholes that allowed entities such as Enron OnLine to operate unregulated trading markets in secret.

I received a letter from Pat Wood, the Chairman of FERC. Chairman Wood writes that neither FERC nor CFTC has adequate authority to determine price transparency and ensure that the energy market is functioning as it should.

He supports this amendment. Commissioner Brownell and Commissioner Massey do too.

Now this amendment does one more important thing: It ensures that entities running on-line trading forums must maintain sufficient capital to carry out their operations, and maintain open books and records for investigation and enforcement purposes.

This last point is very important. Enron saw its future as a "virtual" company. As such, it sold off many of its physical assets over the past few years. And so investors and customers lost confidence in Enron's trades because it no longer held sufficient physical assets as collateral.

This was a major factor in Enron's final spiral into bankruptcy.

Who is supporting this bill? The New York Mercantile Exchange, the Chicago Mercantile Exchange, Cambridge Energy Research Associates, the American Public Gas Association, the American Public Power Association, Pacific Gas and Electric, Calpine, Mid-America Energy Holding Company, Texas Independent Producers and Royalty Association, Consumers Union, and Consumer Federation of America.

I'd like to read from a report released yesterday by the Cambridge Energy Research Associates (CERA) and Accenture which made 12 recommendations to ensure the success of working, competitive energy markets.

One major recommendation calls for the reinstatement of CFTC oversight for energy derivatives and for electronic trading platforms. I would like to submit this report for the Record and I ask unanimous consent that it be printed following any remarks.

Who is opposed to this Amendment? Some energy companies oppose this bill. One lesson some of these companies seemed to have learned from the recent energy crisis was that they make more money when they can operate without any transparency, reporting requirements, or oversight of any kind.

I am encouraged a little bit that not all energy companies seem to want to operate this way. As I mentioned PG&E, Calpine, Apache, Mid America Energy and others support this bill. And many other energy companies are sitting on the sidelines. But there are still some who fail to recognize that the glory days of operating in secrecy are over.

Regardless of what happens with this amendment, Mr. President, I want to go on the record saying that I will do everything in my power to see that the energy sector is exposed to the same price transparency as every other sector. Make no mistake: this debate boils down to the issue of whether energy companies should be able to operate in continued secrecy. Some of these companies have argued that this amendment creates unfair reporting and oversight over energy companies.

Let's look at what this provision would actually do. It would treat electronic trading exchanges just like any other exchanges since-- as I said before, there is neither price transparency nor regulatory authority over these exchanges. So with this provision, the same reporting requirements that the CFTC requires of the New York Mercantile Exchange and the Chicago Mercantile Exchange would now be required of electronic exchanges.

This means simply that the CFTC would be able to exert the same oversight and require the same transparency of electronic exchanges that are already required of non-electronic exchanges.

I have a hard time understanding what is so burdensome and unfair about this.

Additionally, some of these companies have also asserted that this amendment would create unfair burdens on companies engaged in bilateral transactions. Here is what they are complaining about:

With our amendment, any entity engaging in bilateral transactions in energy commodities would have to keep a record of those transactions. And the CFTC would have the authority to look for fraud and manipulation. Again, let me repeat, a company engaged in bilateral trading has to keep a record of that transaction and the CFTC has the authority to investigate fraud. That's it. It is the same authority that was there before 2000 and the same standard that traders of all other commodities are required to meet.

Remember, Enron On-Line was able to escape all federal oversight of its energy trading platform simply because the firm was engaged in bilateral transactions with no reporting or transparency requirements whatsoever. So with all that we now know about the energy sector and Enron I challenge anyone to explain to me why energy companies should continue to have a loophole so they can trade in secret.

The opposition also asserts that we should not pass this amendment because it was less than two years ago that Congress passed the CFMA. With all due respect Mr. President, let me recap again some of the things we witnessed in the energy sector over the past 18 months:

I can go on and on. But the point is we now know what can happen in the absence of transparency and adequate oversight.

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