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Federal Energy Trading Policy EnvironmentorNe
ver Let A Good Crisis Go To WasteGlobal Energy
Management Institute7th Annual Energy Marketing
Trading ConferenceMarch 19, 2009

• Presented by George D. Baker
• Williams Jensen, PLLC
• 1155 21st Street, NW
• Washington, D.C.
• 202-659-8201
• gdbaker_at_wms-jen.com

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What is the situation in Washington these days?

• One picture equals a
• thousand words

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Recall what happened to this happy crew?
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Guess who you are in this picture?
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The people are not happy!
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The fact is that there is so much going on
affecting the energy trading environment, I feel
like this guy trying to get a drink!
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• In D.C. we are not just drinking out of one fire
  hose but several going full blast
• Tarp SEC initiatives
• TARF Mark-to-Market revisions
• Obama budget G-20 meetings
• Stimulus bill Regulatory Reform
• New taxes Hedge Fund Regulation
• And on, and on, and on..

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• All these can affect energy trading, but what is
  at the core of the energy trading political
  environment?

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Todays Presentation

• Themes Dominating Energy Trading Political
  Environment on Capital Hill
• Commodity Exchange Act/CFTC
• CFTC/SEC Merger and Regulatory Reform
• Prospects for a Transaction Fee/Tax
• Energy and Global Climate Legislation

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Political Environment

• Elections have consequences
• Obama removes Bush veto of Democratic initiatives
• Increased House and Senate Democratic majorities
• House 254 Democrats vs. 178 Republicans
• Senate 59/60 Democrats vs. 40 Republicans
• New Administrative Agency Leadership
• Geithner at Treasury
• Gensler at CFTC
• Shapiro at SEC
• Summers at CEA
• Geithner, Gensler, Summers all worked on
  Commodity Futures Modernization Act of 2000 in
  Clinton Administration, and Shapiro is a
  Washington fixture as well

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All Obama policy priorities are dependent on or
secondary to economic recovery

• But that focuses attention on energy trading
• Energy and other commodities affect basic economy
  and consumer/voters perceptions
• Widespread anger and sense of insufficient
  regulation of commodity trading as contributing
  to economic meltdown
• Obama views financial re-regulation as a major
  policy took to advance his economic recovery
  program
• U.S. leadership in international financial
  markets is implicated U.S. caused this
  meltdown and pushed the de-reg model on the
  world
• EU wants a re-regulatory approach

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So how is energy trading viewed in this political
environment?
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Politically significant themes running through
Congresss perception of energy trading

• All---or most---speculation is evil and should be
  limited if not stopped, especially speculation by
  long-only index funds
• Speculation caused the commodity price spikes
  of 2008 and subsequent price collapses in 2009
• Only commercial physical commodity hedgers are
  bona fide
• OTC markets are insufficiently regulated and such
  dark markets have allowed and invited
  manipulation of futures markets

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• Margin can be increased and position limits can
  be imposed on an aggregated basis across all
  exchange traded and OTC product markets --- all
  without adversely affecting the liquidity and
  efficiency of US commodity markets or driving
  transactions overseas outside of US jurisdiction
  
• and if there are such adverse affects, who cares!
• Manipulation is the same as speculation, or at
  least the same as excess speculation

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• I dont represent Wall Street or Greenwich,
  Connecticut and so I dont care what they think
• Relative inexperience and lack of sophisticated
  understanding by Members of Congress re
  commodity trading and relevant regulatory regimes
• CFTCs ability to do the job is questioned

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Q So what is Congresss response to these
perceptions for energy trading policy?
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I. Commodity Exchange Act/CFTC

• Congress is displaying a willingness to broadly
  revisit basic philosophy of the Commodity Futures
  Modernization Act of 2000
• Trust in sophisticated investors is gone and
  with it notion that they deserve less regulation
• Congress is looking for someone to blame for the
  economic mess Speculators and OTC traders are
  the usual nominees as scapegoats
• Strong distrust of OTC markets and skepticism of
  CFTC as cop on the beat
• Perception that OTC trading was predatory,
  manipulative and destructive to cash and exchange
  traded markets

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House Agriculture Committee reported the Peterson
Bill (H.R. 977) in February by voice vote
Chairman Colin Peterson (D-MN)
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Highlights of Peterson bill reflect the range of
issues in play on the Hill for energy trading, so
lets take a quick walk through H.R. 977
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Foreign Boards of Trade/Transparency of Offshore
trading

• Requires Foreign Boards of Trade with any
  contract that trades in US or settles against
  price of any contract listed on a US-registered
  exchange to
• Provide daily trading information comparable to
  U.S. exchanges
• Adopt position limits comparable to U.S.
  exchanges
• Adopt comparable rules to prevent manipulation,
  excessive speculation and disruption of physical
  delivery in cash settlement
• Provide comparable information to CFTC re large
  trader positions and aggregate trade positions

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Detailed reporting and disaggregation of market
data

• Requires CFTC to define and classify index
  traders and swap dealers for data reporting
  purposes for transactions on DCMs, DTEFs, FBOTs
  and ETFs trading significant price discovery
  contracts
• CFTC to disaggregate and publish monthly
• Number and total notional value of index funds
  and other passive, long-only and short-only
  positions, in ALL markets (including OTC?) and
• Data on speculative positions relative to bona
  fide hedgers in ALL markets (again, OTC?)

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Transparency and Recordkeeping

• Subjects OTC transactions for all commodities in
  regulated and exempt markets (swaps) to reporting
  and record keeping requirements as determined by
  CFTC
• Includes OTC contracts as part of large trader
  reporting requirements
• Gives CFTC special call authority to obtain ANY
  OTC market positions, even in exempt
  transactions in order to deter or prevent
  manipulation, disruption to market integrity or
  to diminish, eliminate or prevent excess
  speculation in regulated markets

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Trading limits to prevent excessive speculation
and protect bona fide hedgers

• Requires CFTC to set speculative position limits
  for all physically-deliverable commodities other
  than excluded commodities (financials).
• Applies to all exempt (energy and metals) and ag
  commodities
• Position limits shall apply to spot month, each
  month and aggregate positions for all months
  across all DCMs, DTEFs, or ETFs trading
  significant price discovery contracts
• Requires CFTC to hold bi-annual public hearings
  for agricultural commodities and energy
  commodities to provide interested parties
  opportunity to comment and make recommendations
  re positions limits
• Establishes conditions for CFTCs granting of
  hedge exemption from position limits to restrict
  hedge exemption to bona fide hedgers (largely
  commercial users of the underlying commodity)
• CFTC to define a bona fide hedge

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CFTC employees

• Requires CFTC to hire more employees
• Raises question of how to pay for the new
  employees?
• Increased federal appropriation?
• FY-09 appropriation of 146 million is a 31
  increase and directs CFTC to hire 100 new
  employees
• Beyond FY-09?

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Review of all prior actions by CFTC to ensure
compliance with new CEA provisions

• Compels revisitation of hedge exemptions and
  other exemptions etc.
• If you are relying on a favorable no-action
  letter or exemption, pay attention!!!

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OTC Markets study by CFTC and emergency OTC
position limits authority

• Requires CFTC to study and report on efficacy and
  consequences of potential position limits on OTC
  trading and aggregated position limits across all
  OTC markets, DMCs and DTEFs for agricultural and
  energy commodities
• CFTC could impose position limits for speculators
  in Ag and Energy OTC markets if that OTC trading
  is determined to have potential to disrupt
  liquidity and price discovery functions of
  exchange traded markets, cause severe market
  disturbance, or prevent prices from reflecting
  supply and demand

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Clearing of OTC Transactions

• Generally all prospective exempt OTC transactions
  and swaps must be settled and cleared through a
  CFTC-regulated clearing house
• OTC transactions in an excluded commodity (i.e.
  financials) may be settled and cleared in an
  SEC-regulated or FED-regulated clearing house

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• Exemption from General Mandatory Clearing Rule
• CFTC can exempt a contract or class of contracts
  if
• Highly customized
• Transacted infrequently
• Does not save significant price discovery
  function
• Parties demonstrate financial integrity of the
  contract and themselves and shall include a net
  capital requirement for contract recognizing the
  risks associated with the absence of clearing
• Contract, once executed, is reported to CFTC (or
  SEC or FED)

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• All OTC transactions prior to enactment must be
  cleared or reported to CFTC
• Concerns
• Not all OTC products may be suitable for clearing
• CDS clearing houses not yet necessarily ready to
  go with clearing for all OTC products

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Carbon Trading

• Excludes carbon/GHG allowances from exempt
  commodity definition, thus requiring such trading
  to be on futures exchanges and thus be regulated
  by CFTC
• Divergent views exist on which agency should
  regulate CO2/GHG trading
• CFTC
• FERC
• EPA
• DOE
• SEC

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CFTC Inspector General

• Makes CFTC Inspector General a Presidential
  appointee to be confirmed by the Senate

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Emergency Suspension of Credit Default Swaps

• Grants CFTC authority to suspend CDS trading with
  concurrence of the President during any period of
  SEC prohibition on short-selling
• CFTC order only applies to
• CDS on specific securities subject to and for
  duration of SEC short-selling suspension
• CDS NOT purchased to reduce an existing risk
  related to the reference entity or its
  obligations (naked)

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CFTC Criminal Authority

• Grants CFTC authority to initiate and conduct
  criminal proceedings under CEA if DOJ declines

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How about the Senate?, you ask.There are
Senate proposals that reflect similar issues to
those contained in the Peterson bill
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Senate Agriculture Chairman Tom Harkins Bill
(S. 272) Derivatives Trading Integrity Act of
2009

• Eliminates excluded and exempt commodities
  categories in CEA, thus requiring all financial,
  energy and metal derivatives commodities trading
  to be on exchange, period!
• Eliminates CEAs swap exemption
• Looking to expand S. 272 and markup a bill in
  coming months
• Could be vehicle for a wide range of other energy
  trading and energy policy provisions on Senate
  floor!
• Could be rolled into a larger energy bill that
  Democrats want to do in 2009

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Senator Levin (D-MI) and Senator Bingaman (D-NM)
Prevent Excessive Speculation Act of 2008

• Thematically similar in many ways to Peterson
  bill
• Authorize CFTC to impose speculation limits on
  OTC transactions in all energy products and
  CO2/GHG allowances
• Closes swaps loophole for energy and ag
  commodities
• Limits hedge exemption to commercials
• Close London loophole (FBOTs)

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Even without new CEA legislation, expect CFTC to
take action

• CFTC concept release re use of hedge exemption
  by index traders
• Public comment solicited soon
• Culminate in a rulemaking
• New CFTC Chairman Gary Gensler
• Senate Ag confirmation hearing held in February
• Hearing was delayed Senate floor action still
  delayed by some Senators expressing concerns
• Chairman Harkin extracted admissions of
  deregulatory mistakes from Gensler re his role
  in CFMA of 2000
• Gensler clearly signaled intention to
• Revisit all hedge exemptions and no-action
  letters and process for issuing no-action letters
• Require all standardized OTC contracts to be
  cleared
• Subject all OTC dealers to increased regulation
  (record keeping reporting)
• Supports treating all physical commodity futures
  the same (Ag vs. Energies)

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II. Transaction Fee/Tax
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A Bit of History

• The last several Bush Administration budgets all
  proposed a futures transaction fee to recoup cost
  of CFTC enforcement program (87 million)
• Congress always rejected the Bush transaction fee
• But that was pre-market meltdown and pre-TARP
• Obama budget (thus far!) does not propose a
  transaction fee, but more details are expected
  soon

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Rep. DeFazio (D-OR) H.R. 108

• Let Wall Street Pay for Wall Streets Bailout
  Act of 2009
• TARP already has a payback provision requiring
  President to produce a plan 5 years from now to
  recoup net deficit in TARP from the financial
  industry
• DeFazio would impose a tax on each covered
  securities transaction equal to the lesser of
• a specified percentage set by Treasury to recover
  revenue equal to the net cost to the Federal
  Government of the TARP and the Feds actions
  (that is a lot of !) or 0.25
• Covered securities transaction includes
  anything traded under SEC Act and any transaction
  subject to CFTC jurisdiction futures
• potentially includes exempt products (energy,
  metals) or swaps or OTC products

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Illustration at 0.25

• Assume euro dollar contract with 1 million
  notional value
• 1 million x 0.25 2,500
• Currently, exchange charges 8 cents!

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Senator Grassley (R-IA) and Senator Wyden (D-OR)

• 2008 Discussion Draft
• Treat Capital Gain or Loss from sale or exchange
  of oil and natural gas commodities as short term
  gain or loss
• Would apply to oil and gas trading, indexes,
  derivatives, or any option, forward, futures,
  short position or any similar instrument
• Would eliminate 60/40 tax treatment for futures
  or mixed straddles
• Would look thru to treat pro rata share of
  income or loss of foreign corporations that
  invest in defined commodities in same manner as
  if the commodities were owned directly by the
  investor in the foreign corporation
• Treat gains and losses of tax-exempt investors in
  defined commodities as unrelated business taxable
  income

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III. CFTC/SEC Merger

• Lots of talk Gensler opposes Shapiro more
  sanguine
• Strongly opposed by Congressional Ag Committees
• Somewhat supported but not a priority for House
  Financial Services and Senate Banking
• Current priority is systemic risk regulator
• Fed?
• Pros and Cons
• Obama Financial Regulation Reform Proposal
  Perhaps just principles for now
• Aspiration Release before Obamas G-20 Summit
  in April
• Reality Treasury has its hands very full and
  lacks nomination/confirmation of senior personnel

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IV. Energy and Global Climate

• High priority for Congressional Democrats and
  Obama Administration for 2009
• Query Impact of economy on timetable
• Aspiration December 2009 meeting in Copenhagen
• Fight brewing over who will regulate CO2/GHG
  trading
• CFTC
• SEC
• EPA
• FERC
• Each agency has its Congressional proponents

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Energy Bills Renewable Portfolio Standard (RPS)

• Will encourage national trading market for RPS
  credits
• Proposals begin with 4 RPS in 2012 and variously
  ramp up to 15, 20 and 25 RPS by 2020

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Bottom Line

• The energy trading plate is very full and laden
  with uncertainty
• Expect plenty of legislative and administrative
  activity in 2009
• Prospects for significant regulatory changes are
  high

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Questions
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(No Transcript)