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DARK EXCHANGES


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The New England Fuel Institute is fighting for transparency in emerging fuel trading markets

By Stephen Bennett


Excessive speculation and volatility on the energy commodity markets have impacted small business fuel dealers and the American energy consumer, Sean Cota, president of the New England Fuel Institute, told a Senate subcommittee.

Cota’s testimony and an Op-Ed piece in The Boston Globe by James Collura, vice president for government affairs at the New England Fuel Institute, are key elements of a lobbying campaign by the regional trade group to shine light on so-called “dark exchanges,” made possible by the often called “Enron Loophole,” created in federal legislation that became effective in 2000. NEFI wants legislators to close the loophole.

“Seven years ago, Enron lobbyists sought to free their new experiment in electronic trading, ‘Enron Online,’ from oversight by the principle regulator of energy futures and derivatives, the Commodity Futures Trading Commission,” Collura wrote in his Op-Ed piece. “They managed to drop a loophole into an appropriations bill that has effectively exempted all electronic over-the-counter energy commodity markets from U.S. regulation. Before this bill was passed, crude oil was under $25 per barrel and motorists enjoyed affordable gasoline. Since then, energy commodity traders and hedge funds have poured billions of dollars into these ‘dark markets.'”


Cota testified to the Senate’s Permanent Subcommittee on Investigations (PSI) on June 25. Two days later the chairman of the U.S. Commodity Futures Trading Commission (CFTC) resigned, NEFI reported in its July 13 “Legislative Alert.”

Since then the following developments have occurred, NEFI reported:

During a follow-up Senate PSI hearing on July 9, the New York Mercantile Exchange (NYMEX) and the InterContinental Exchange (ICE) endorsed closing the “Enron Loophole” and bringing greater accountability to energy commodity markets. “This is a major, 180-degree turn for ICE, which is currently a dark market and is not regulated by the CFTC,” NEFI noted in its Legislative Alert.


Senator Jack Reed (D-R.I.), chairman of the Senate Financial Services Committee called on the Government Accountability Office to study differences between the CFTC, which regulates commodities, and its sister agency, the Securities and Exchange Commission, which regulates the stock market.

In concluding his testimony to the Senate’s Permanent Subcommittee on Investigations, Cota, on behalf of NEFI, recommended that Congress take the following actions:

Encourage the CFTC to revisit its use of “no-action” letters, which virtually exempt foreign boards of trade that allow electronic U.S. access to their platforms.

Investigate whether or not the Atlanta-based ICE intentionally established its operations in London to circumvent U.S. regulation.


Require large position data collection requirements for all U.S. destined contracts of commodities essential to the health and welfare of American citizens, including heating oil, propane and natural gas.

Fully fund the CFTC to levels appropriate to upgrade infrastructure, data collecting capabilities and to meet necessary personnel requirements.

Encourage the CFTC to be more vigilant in its enforcement of its own data collection requirements and hold the dark exchanges to the same rule of law that is expected of designated contract markets such as the NYMEX and the Chicago Mercantile Exchange.

Continue to hold energy exchanges, financial firms, market traders and hedge fund managers to account; continue to conduct hearings and collect information in the years to come; and moreover, make every effort to educate your constituency – the U.S. public – on the truth of this issue.

In a joint NEFI-PMAA (Petroleum Marketers Association of America) member survey of heating fuel providers earlier this year, excessive volatility and the need for greater transparency and accountability in the energy commodity markets ranked as the number one public policy concern for member companies.

Here are additional excerpts (slightly edited) of Cota’s June 25 testimony to the U.S. Senate Permanent Subcommittee on Investigations.

Cota testified that in the winter of 2005-2006 the National Oceanic and Atmospheric Administration reported state average temperatures in much of the country, especially in the Northeast, running significantly higher than normal. Additionally, the Energy Information Administration repeatedly reported that national stocks of distillate fuel oil remained high as a result of the decreased demand due to the warm weather. In the following excerpt, Cota describes how these circumstances did not affect the fuel market in the way that would have been expected based on historical patterns.

(Despite) the warm weather, decreased demand and high inventories of these fuels, heating oil prices remained high, with New York Harbor spot prices averaging $1.82 per gallon through the season. In an effort to find the cause of this anomaly, the New England Fuel Institute commissioned a study to find the root cause of the market’s strange behavior in light of these facts. However, they ran up against a wall because of the inability to gather the data needed on over the counter trades, upon which a majority of price setting activities occur. Without this valuable information, the report remained incomplete.

The reason – we were surprised to find out – was that the principal regulatory body responsible for collecting data and policing the energy commodity markets, the CFTC, was not collecting the data due to a series of legislative and regulatory loopholes exempting over the counter exchanges and foreign boards of trade with U.S. destined contracts from federal oversight. It is upon these ‘dark exchanges’ that traders may be tempted to engage in dubious and manipulative trading practices, free from the reach of U.S. regulators.

Do not be mistaken. We do not oppose the free exchange of commodity futures on open, well-regulated and transparent exchanges that are subject to the rule of law and accountability. In my own company, for example, I rely on these markets to hedge my product for the benefit of my consumers. In an effort to protect my customers against roller coaster like price volatility on the energy commodity exchanges, I engage in hedging activities.


Sean Cota,
NEFI President

[Editor’s note: Cota is co-owner and president of Cota & Cota Inc., a heating fuel company in Bellows Falls, Vt.]

(Cota & Cota has) been offering fixed price programs to our customers for the past two decades. At first, we filled our fuel storage in the summertime and sold those gallons to our customers until we ran out of those gallons. However, my storage, although large by industry standards, is still very limited. We have available six days of January supply in storage capacity.

It quickly became apparent, due to customer demand, that we would need a different method of providing fixed price programs. It was at that time that we began to enter into NYMEX-based futures contracts with our suppliers so that we could continue to offer these programs to our customers. These independent suppliers of wholesale fuels would purchase NYMEX contracts for future delivery and, in turn, resell these contracts to me after a profit was added. This is the current system in which we continue to financially hedge heating fuels for our customers. This is typical for the industry.

Because heating fuel is a bell curve where January is much colder than other months, customers buy a single annual contract from me while I, in turn, purchase ten NYMEX monthly contracts to match temperature and demand. Because my minimum hedge is ten contracts or 420,000 gallons, with the typical customer purchasing 900 gallons per years, I hedge for approximately 450 customers at a time.

There have been significant changes in the behavior of the market since we first began purchasing NYMEX based contracts, the largest of which is market volatility. Traditionally when we purchased futures contracts, the coldest winter month, January, was more expensive than the warmest summer month of August. The rate of difference was usually something slightly larger than the interest cost of money. The past few years we have seen the difference between the summer months and the winter months (“contango,” or “carry”) be as high as 23 cents per gallon.

Up until about four years ago, it would have been abnormal to have a daily move in the market of larger than one-half of one cent. Today it is typical to see five cent daily moves and moves as high as 12 cents. In recent years we have witnessed energy market moves of more than one dollar per gallon. We used to offer insurance programs as an alternative to fixed pricing for our customers. These “option-based” programs have had the highest increase in volatility. Four years ago we were able to purchase an “at the money,” “put” and “call” at a reasonable cost for our customers. This transaction would enable customers to be protected if prices went up or down from the current price. Four years ago my cost on this type of transaction for a January contract purchased in the summer would have been between four and six cents per gallon. Today that same program would cost me in the area of 40 cents per gallon. We have seen it as high as 50 cents per gallon.

Currently, these fixed price programs make up 70 percent of my total sales, approximately 65 percent of which is heating oil, 30 percent is propane and five percent home heating kerosene. In a business that makes profit in cents per gallon, these are some of the reason why it is much more difficult to continue to provide these fixed price programs to our customers. Unlike many players in the market, who make these commodity investments for pure financial gain, we, as an industry, are hedging directly for consumers. Consumers are being injured by these huge financial players speculating on the market…


The dark exchanges are increasing in both number and reach. On June 1, 2007, the New York Mercantile Exchange opened a Dubai-based Mercantile Exchange and launched an Oman crude oil futures contract. The CFTC was quick to issue a ‘no-action’ letter exempting the exchange from its oversight rules.

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