So the planet is saved after all. The leaders of the world’s eight biggest industrialised nations have embraced the goal of cutting greenhouse gas emissions by 50 percent by 2050, and the need for developed countries to cut their own emissions by 80 percent by the same date from their 1990 levels.
– John Kemp is a Reuters columnist. The views expressed are his own –
By John Kemp
LONDON, July 8 (Reuters) – The U.S. Commodity Futures Trading Commission (CFTC)’s review of position limits and proposed enhancement of the weekly commitment of traders (COT) reporting system has generated a lot of comment about moves to tighten commodity regulation, but it is not year clear whether the proposals will amount to much.
At this stage, all the commission is promising is a slightly more detailed breakdown of the categories in the weekly COT report, which will disaggregate positions held by swap dealers, index funds and managed accounts (hedge funds) rather than the current simple dichotomy between commercial and non-commercial traders.
CFTC Chairman Gary Gensler has also promised to hold public hearings later this month and in August on whether the commission should extend the existing position limits it applies to agricultural contracts to all commodities in finite supply (such as oil, heating oil and natural gas); and whether the current rules for granting bona fide hedging exemptions should be tightened.
Holding hearings does not commit the CFTC to take substantial action, and it will come under intense pressure from futures brokers and investment banks not to make substantial changes to the current regulatory regime.
There are three key issues at stake in the review process:
(1) FEDERAL POSITION LIMITS
At present all commodity futures contracts in the United States are subject to position limits. The commission itself sets limits for agricultural contracts (“federal position limits”). For other contracts, limits are set and enforced by exchange operators under the commission’s oversight (“exchange limits”). In each case, market participants can apply to the commission or the exchange, as appropriate, for permission to exceed the limits where this is needed for “bona fide” hedging purposes.
The commission will consult on whether it should set federal limits on all contracts, bringing practice in the energy markets into line with the existing system for agricultural contracts. But this is a distinction without a difference. It is just a bit of bureaucratic tidying up.
There is no evidence federal limits are any more binding or effective than exchange-set ones. The Senate Permanent Subcommittee on Investigations’ recent report on excessive speculation in the wheat market blamed the influx of investment money for the rise in wheat prices, in a market that was subject to federal rather than exchange limits (http://graphics.thomsonreuters.com/ce-insight/EXCESSIVE-SPECULATION-IN-WHEAT.pdf).
Unless the existing exchange limits are going to be reduced, or the criteria for granting exemptions are tightened, shifting from exchange to federal limits is unlikely to make a material difference.
(2) UPGRADING THE COT REPORT
The existing commitment of traders report is deeply flawed. Part of the problem is that it divides all market participants into just two categories: commercial users (producers, consumers and inventory holders) who are assumed to be using the market to hedge, and non-commercial users (such as index managers and hedge funds) who are assumed to be investing or speculating. This division is far too crude. Index managers have a much more passive impact on prices than an active hedge fund manager for example.
So a more detailed breakdown that separated out swap dealers and index managers’ positions would be welcome. The commission already breaks out index positions for some of the smaller agricultural contracts following previous complaints about the distorting effects that large index positions were having in these relatively shallow markets.
But the real problem with the COT reports is their focus on classifying users rather than positions. At present, the CFTC classifies each user as either commercial or non-commercial depending on the predominant nature of its business, then allocates all that user’s positions to the commercial or non-commercial category as appropriate.
For example, an airline or an oil company would probably be classified as a commercial user and ALL that company’s trades would be allocated to the commercial category. But that simple allocation process leads to problems where some market participants (such as oil and gas companies with active trading desks) conduct a mixture of hedging and speculative transactions.
As a result, the existing COT reports overstate the degree of hedging and understate speculation because many of the positions currently in the commercial category are actually speculative positions taken by the trading desks of oil and gas companies, or even physical trading companies that have secured commercial status.
Unless the COT report is reformed to start classifying positions rather than trades, it is hard to see how the new categories will make it much more useful.
(3) HEDGING EXEMPTION CRITERIA
The million dollar question is whether the CFTC will tighten the criteria under which it (or the exchanges) grants exemptions to the position limits for “bona fide” hedging operations. The CFTC and NYMEX have been sharply criticised by congressional investigators for granting so many exemptions that the limits have become meaningless.
But the position is more subtle than many commentators have suggested. Everything depends on what is meant by “hedging”. Gensler’s press statement noted that “Recently, the Commission completed a comment period on whether the bona fide hedge exemption should continue to apply to persons using the futures markets to hedge purely financial risks rather than risks arising from the actual use of a commodity”.
Exemptions were originally granted to commercial market participants using futures contracts to hedge risks from producing, consuming or storing physical commodities. If the commission restricted exemptions to these categories it would represent a radical toughening of the rules. Exemptions for investment banks and others operating commodity index funds would have to be withdrawn and positions scaled back.
But most banks and other index operators would argue that they too are hedging. The products they have sold to pension funds and others (usually swap contracts where the bank promises to pay the buyer a return based on the prices of commodities in an underlying basket) leave them with just as much exposure to price risks as producers and consumers of the physical commodity.
In fact, it was precisely because the commission and the exchanges accepted this definition of hedging that most of the exemptions were granted over the last decade in the first place. Banks and other index operators will argue the commission should continue to recognise this as a legitimate form of hedging. The alternative is that products would have to be withdrawn and investors’ access to commodities as an asset class would be sharply reduced.
As a result, banks will lobby hard to preserve the “financial hedging” exemption for commodity index operators. If the CFTC accepts this argument, nothing much will change.
(Edited by David Evans)
This story from today’s Washington Post is one of those where the headline could have been “Cap and trade plan divides voters” as easily as “Limits on emissions have wide support”. Public opinion on climate change action is very sensitive to how the plan (and the consequences) are framed.
There is fairly widespread approval for the government to take some action to limit greenhouse gas emissions — but only if the resulting rise in energy costs stays low. If it involves sharper rises in the cost of energy, support begins to erode rapidly.
It is one reason that proponents of climate-change action have settled on a very gradualist approach — one which deliberately defers and obscures costs — as the best way to get a cap-and-trade based system through Congress.
from John Kemp:
Businesses outside the farm sector plus federal, state and local governments continued to eliminate positions on net last month (-345,000) but the rate of job losses was the smallest since the recession worsened in Sep 2008.
The data is consistent with recent business surveys suggesting the pace of contraction is slowing, and the turning point in the economic cycle is drawing near.
The relatively small decline in nonfarm payrolls should be reflected in a smaller decline in industrial output when the Federal Reserve reports its May 09 estimate later this month (not least because the Fed bases its estimate, in part, on the payroll data).
In the past two months, the data flow has become consistently positive, in the sense that it points to a slower rate of decline and a nearing end to the contraction phase of the cycle, helping fuel the broad-based rally across equity and commodity markets. Today's data will reinforce that optimism, and has already sent WTI futures (briefly) back above $70.
(Un)-employment is a lagging indicator. Job losses are likely to continue even once the economy starts to expand again and will act as a (moderate) drag on growth going forward (as well as contributing to further defaults on home mortgages and consumer lending over H2 2009 and throughout H1 2010).
But the payrolls report does indicate the worst of the downturn is now over.
from John Kemp:
Like a party of drunken millenarians not sure whether to anticipate rapture or apocalypse but certain they are on the brink of something big, financial markets and commentators lurch from one extreme to another - absurd over-optimism to doom-laden pessimism. Reality is almost always more prosaic. Economic history is about "muddling through".
The Black Death (1348-1351), to take perhaps the greatest catastrophe to befall Europe, carried away a third of the population, but two thirds survived, and somehow life went on. The Great Depression cut U.S. manufacturing output in half between 1929 and 1933, but still left plenty of factories working -- albeit on severely reduced time. Cars were still produced, crops harvested, and a few houses and factories built.
Bread lines and work camps make better copy than thousands of people somehow struggling to cope and survive. But they are only part of a more complex reality. While John Steinbeck was the greatest reporter of the Depression, the bleakness of "The Grapes of Wrath" is only one part of rich heritage that includes characters coping in straitened circumstances in "Cannery Row".
Financial history is about the highs and lows, exuberance and panic. Social and economic history is about the middle ground, continuity as much as change.
At the moment, markets are seized by the excitement of "green shoots" of recovery. Not for the first time, participants are in danger of losing perspective.
While the pace of decline has slowed in North America, Western Europe and Japan after the free-fall contraction of Q4 and Q1, manufacturing activity is still shrinking. Even if the economy hits the trough in the next 1-4 months, as expected, and a recovery begins, it is likely to be fitful and uneven.
The attached chart on rail freight volumes in the United States (a good proxy for manufacturing and construction activity) provides some indication of the continuing difficulties.
Freight volumes are still trending lower. The year-on-year deficit has widened from -14% at beginning of Mar to -18% at the beginning of Apr, -21.6% at the beginning of May and -23.5% at the start of Jun.
While a recovery is coming, it is not here yet, and the trajectory when it comes is anything but certain.
from John Kemp:
I realise there are a small number of people for whom the weekly US REFINING SUMMARY is not the most compulsive reading material, with a plot line to rival John Grisham and prose that bears comparison with Shakespeare.
So for these few benighted individuals, I attach a simple graphic:
It shows the stock of "other oils" reported by refiners, pipeline companies and tank farm operators across the United States each week in the EIA's weekly survey.
Other oils is a miscellaneous category of refinery products after gasoline, distillate, jet fuel, propane, residual fuel oil and part-finished oils have been separately accounted for.
It includes, according to the EIA, "aviation gasoline, kerosene, natural gas liquids, LRGs, other hydrocarbons and oxygenates, aviation gasoline blending components, naphtha and other oils for petrochemical feedstock use, special naphthas, lube oils, waxes, coke, asphalt, road oil, and miscellaneous oils. Includes naphtha-type jet fuel beginning in 2004."
Now these are hardly what you might expect as major refinery products. But it is one of the fastest growing parts of the US product inventory.
The inventory of "other oils" has risen by +24.202 million bbl (+18%) in the seven weeks since Apr 10. Other oil stocks (158.600 million bbl) are now +20.500 million bbl (+14.8%) higher than at the same time last year (138.100 million). They are climbing exponentially, up by +3.600 million bbl last week alone.
That amounts to a large amount of extra lube, asphalt, or petchem feedstocks.
So what exactly ARE the refiners producing and presumably storing here?
It also looks rather like refiners have been producing and reporting these "other oils" in a bid to reduce over-production of something else (gasoline? distillate? resid?) amid soft demand.
The implication is that the market is rather more over-supplied with refined products than a simple tally of gasoline and distillate inventories would suggest.