CFTC Closes ‘Enron Loophole’ for Seven Gas Contracts

Seven natural gas contracts traded on Intercontinental Exchange Inc. will face new regulations including limits on the number of contracts a single trader can hold, the Commodity Futures Trading Commission decided today.

The commission voted unanimously at a hearing in Washington to impose regulations on the seven ICE contracts. The board considered regulation of 24 natural gas, electric and carbon contracts on the Intercontinental Exchange Inc., the Natural Gas Exchange Inc. and Chicago Climate Exchange Inc.

The commissioners closed for these products the so-called Enron Loophole, which exempted certain electronically traded contracts from regulation. It was named for Enron Corp., the Houston energy company that lobbied to insert the provision in the Commodity Futures Modernization Act of 2000. Enron declared bankruptcy in 2001.

“Congress recognized the danger such a loophole posed to the American public,” Commission Chairman Gary Gensler said in a statement prepared for the hearing.

The instruments to be regulated are the NWP Rockies Financial Basis Contract, HSC Financial Basis Contract, PG&E Citygate Financial Basis Contract, Waha Financial Basis Contract, Chicago Financial Basis Contract, Socal Financial Basis Contract and the Alberta Financial Basis Contract.

Price Discovery

Congress gave the commission authority, through a provision in the 2008 Farm Bill, to impose rules on some contracts if the commission found they served a “significant price discovery function.”

“Commodity investors are facing increased regulatory efforts, and are really concerned that these regulations may force liquidity out of these markets,” Teri Viswanath, director of commodities research with Credit Suisse Securities USA in Houston, said in a telephone interview.

The commission voted unanimously not to regulate the remaining contracts on ICE and the Natural Gas Exchange, and the carbon contract on the Chicago Climate Exchange.

The loophole was blamed for the collapse of Amaranth, a hedge fund that folded after losing $6.6 billion on natural gas bets in 2006, according to a U.S. Senate investigation. The fund sidestepped limits on the New York Mercantile Exchange by buying electronic look-alike contracts on ICE. Those bets allowed it to amass risk outside the view of regulators, according to the Senate investigation.

Imposing Limits

The natural gas contract on ICE that was used by Amaranth was the first one targeted by the commission, and regulations went into effect in February. That designation meant that ICE had to impose limits on the number of contracts one trader can hold similar to the restrictions on Nymex.

“This is a significant effort,” said Michael Greenberger, former director of trading and markets at the commission. The commission needs to use its existing authority to clamp down on speculation even as it asks Congress to expand its reach to the over-the-counter market, he said.

Natural Gas Exchange Inc. in Calgary, Canada’s leading energy exchange, opposes regulation of five of its contracts, according to a Nov. 5 letter sent to the commission.

The California Public Utilities Commission supports regulation of contracts based on power prices in that state, according to an Oct. 23 letter from the utility commission to the CFTC.

California Power

Oversight of the contract linked to California power prices “may discourage market manipulation that could impact California’s energy prices,” the utility commission said in the letter.

The Western Power Trading Forum, an organization that promotes competition in the Western power markets, and the Natural Gas Supply Association both wrote letters to the commission opposing regulation of some of the contracts.

Gensler predicted last year that the CFTC would exert its significant-price-discovery authority over the carbon financial instruments traded on the Chicago Climate Exchange. In public comments, the Intercontinental Exchange said the carbon financial instrument is a “spot contract” with “no open interest and settling the next day” that shouldn’t be brought under CFTC authority.

The climate exchange is a voluntary program based on pledges from companies such as Columbus, Ohio-based American Electric Power Inc. and Dearborn, Michigan-based Ford Motor Co., to cut back their output of carbon dioxide and other greenhouse gases that scientists have linked to global warming.

The program started in 2003 and its members have promised to cut their emissions 6 percent by the end of this year. Companies that cut their emissions by more than this amount can sell carbon financial instruments they don’t need to firms that fall short of the target. Carbon offsets, or pollution cuts from sources like farms and landfills, can also be used to meet the target.

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