Thank you very much.
It's an honour to be asked to testify before you today. We in America look with great admiration to Canada, because its regulatory controls softened the most recent great recession. There's a lot the United States can learn from the Canadian regulatory system.
I had the pleasure of being in Ottawa two weekends ago at the Canadian Economics Association conference, at which I talked. I learned a great deal, and we in the United States have a great deal to learn.
My comments really reflect agreement with much of what Mr. McTeague just said, and I want to expand upon that.
We are today, in the United States, engaged in a massive debate about whether the cause of price increases in crude oil, and its important derivative, gasoline, is a reflection of supply and demand or what we in the United States refer to technically, because of our statutes, as excessive speculation.
There's no doubt that when Congress passed and President Obama signed into law the Dodd-Frank financial regulation reform bill on July 21, 2010, the United States Congress weighed in heavily on the great concern about excessive speculation--which has nothing to do with putting money towards production--being not the sole problem here but a great cause of the problem.
In hearings about three weeks ago before the United States Senate finance committee, the CEO of ExxonMobil, when asked what the price of crude oil should be if supply and demand fundamentals were at work, said between $60 and $70. As you know, if you're looking at WTI, it's up at around $100. If you're looking at the Brent price, it's considerably higher than that.
In mid-April, Goldman Sachs, in an analyst's report, said that the present price of crude oil is reflective of excessive speculation, to the tune of about $25 to $30, and has nothing to do with supply and demand. At the same time, President Obama, in a press conference, said that the problem here is not supply and demand; it's one of speculation.
Let me talk a little bit historically about how speculation adversely impacts the market. One of the first pieces of legislation Franklin Delano Roosevelt sent to the New Deal Congress in 1934 was what became the Commodity Exchange Act of 1936. In those days, the only futures markets were agricultural markets. For 10 to 15 years before the Great Depression, farmers had complained about speculators coming into the markets that are designed to hedge either the producer or the consumer of production--hedging vehicles in the futures market. Excessive speculation distorted those markets and unmoored them from price-demand fundamentals.
President Roosevelt established the framework for the Commodity Exchange Act. When the act was passed in 1936, one of the goals of the regulation was to limit excessive—and I emphasize the word “excessive”—speculation in these markets. And the tools to be used to limit speculation were position limits. What were position limits? They were determinations made by commodity regulators, on a market-by-market basis, that drew a line between the liquidity needed in the market or the speculation needed in the market to create appropriate liquidity for the producer and the consumer of the commodity, and a ban or a bar on so much speculation that the market would become unmoored from price-demand fundamentals.
The futures markets are price discovery markets. You know how much to charge or pay for a barrel of oil by looking to the futures market. If the futures market is unmoored from price-demand fundamentals, the price everyone pays is unmoored from price-demand fundamentals.
From 1936 to 1991, with the regulation of these markets, while there may have been volatility, the volatility was always explained by supply and demand fundamentals, such as during the Arab boycott, in 1973, when they stopped exporting oil to western countries.
In 1991 Goldman Sachs received the first of a series of rulings--not by the Commodity Futures Trading Commission, which is the regulatory agency involved, but by its staff--that if investment banks were selling bets on the price direction of commodities.... That is to say, a customer approaches the bank and says, “I want to bet on the direction of a commodity” without the customer owning it. It's just a simple bet just as you'd bet on a soccer match. You don't own the soccer team, but you're betting on the results. Goldman, through its subsidiary J. Aron, convinced the staff of the CFTC that in hedging that bet, they were acting, in this instance, as an oil producer or an oil consumer. They had a business need to hedge their bets, and they therefore gained exemptions from the position limits.
So from 1991 to the summer of 2008 there were many people in these markets who were deemed commercials, who were doing nothing more than hedging betting. The betting has gone from about $13 billion in 2004 to about $450 billion today. The principal vehicle, although there are many for these kinds of bets, is as follows. Goldman and Morgan Stanley offer wealthy customers--pension funds, private equity, other banks, wealthy investors--the ability to come to the investment bank to place a bet. You can only place a bet that the price of the commodity will go up.
The vehicle is a commodity index swap, an unregulated entity prior to Dodd-Frank, which is a basket of 25 commodities assembled by the investment banks, allowing the customers to place a bet that the basket will go up. The basket is very heavily weighted toward WTI, the United States benchmark for crude, and Brent. The basket became more heavily weighted to Brent quite recently, which is an explanation offered for the divergence between WTI and Brent, Brent being a much more expensive but much less reliable fuel source.
Using these exemptions, these investment banks have come into the futures market and laid off their risk from their bets with their customers to buy long positions that correspond to the commodities in the commodity basket. That is why we are experiencing a price spike today not only in crude but also in copper, rice, cotton, wheat, etc.
The United States Congress, when it passed Dodd-Frank, passed a provision that said in markets that were previously regulated and in markets that were previously unregulated, the Commodity Futures Trading Commission shall impose aggregate position limits to limit this kind of speculation in order to bring the markets back into conformity with supply and demand fundamentals.
On January 26, 2011, in the Commodity Futures Trading Commission, on a four-to-one vote, there was a proposed rule that essentially codified the status quo ante. In other words, they acknowledged that the speculation hedging should continue. The vote was four to one, with two commissioners firmly in support and two commissioners saying they likely would not support this rule when it came back in final form. On that day a signal was sent to these markets that Dodd-Frank would not be implemented. There weren't even three of five votes for a weak regulation on speculation.
As you know if you look at the date, since January 26 the price of oil has gone up in the neighbourhood of 35% to 40% because that was the day a signal was sent.
Congress is beginning to again go through an exercise of trying to recraft what they did in Dodd-Frank. Although there is tremendous resistance to the regulation, the House Republican-controlled Congress just voted for a 15% decrease in CFTC staff, which would take that commission, with $300 trillion of jurisdiction and new legislation, down to 500 employees.
But there is an effort being made to once again limit speculation in these markets to get the CFTC to adopt strong limits. One might ask what Canada can do. I would suggest that Canada can do what France just did. President Sarkozy, in anticipation of the G-20 meeting for agricultural ministers that is coming up, announced that France was in great support of meaningful position limits. The European Commission is moving in this direction. If I had to say who the culprits are out there now in terms of governments, I worry greatly about my own government, the United States, and the United Kingdom--