By Asjylyn Loder Jan. 14 (Bloomberg) -- The Commodity Futures Trading Commission will take another step today in its efforts to rein in energy speculation, proposing hard limits on the number of futures a single investor can hold. Swaps dealers, index funds and commodity traders have been waiting for the proposal since July and August, when the commission held hearings amid concerns that speculators drove oil prices to a record high of $147.27 a barrel in 2008. Commission Chairman Gary Gensler has pushed for tighter rules on energy speculators, calling for strict limits on who is exempt from regulation. He has also asked Congress for authority to regulate over-the-counter markets, where traders can sidestep restrictions by buying unregulated, bilateral contracts. “It’s likely that the limits that they set will be pretty liberal and generous,” said Craig Pirrong, director of the Global Energy Management Institute at the University of Houston. “The main issue will be how generous the exemptions will be for swap dealers and other financial market participants.” The so-called position limits may apply to energy futures on regulated exchanges such as the oil and natural gas contracts traded on the New York Mercantile Exchange. The restrictions are designed to control risk and to keep one trader from gaining too much control of the market. CME Group Inc., owner of the New York Mercantile Exchange and the Chicago Board of Trade, proposed rules of its own in September that would have limited traders to 10 percent of the first 25,000 contracts of open interest in a single month, with a 5 percent increase for each 25,000 of open interest thereafter. Investors would have faced an all-months combined limit of 150 percent of the single-month limit. OTC Markets The CME said that hard position limits would be ineffective if the CFTC didn’t gain power over the OTC market. Tighter limits would push traders to shift their positions to the over- the-counter market or unregulated exchanges overseas. The $4.7 billion U.S. Natural Gas Fund, the largest exchange-traded fund in the fuel, began shifting to OTC contracts in July in anticipation of new restrictions, and has $2.4 billion, or more than half its assets, in OTC swaps, according to its Web site. Without authority to police the OTC markets, the commission can’t pursue strict position limits because there are too many loopholes traders can exploit, said Stephen Schork, president of consultant Schork Group Inc. in Villanova, Pennsylvania. “The whole thing is political,” said Gary Dewaal, group general counsel in New York for Paris-based Newedge Group, which calls itself the world’s largest futures broker. “Energy prices were the bogeyman before the financial crisis.” Doing Something The commission has to be seen as doing something to curb speculation, Dewaal said. Gensler’s focus on large, concentrated positions likely means that position limits will be set high, and that most traders won’t be affected, he said. Congress gave the commission authority, through a provision in the 2008 Farm Bill, to impose rules one some contracts if the commission found they served a “significant price discovery function.” As a result, the CFTC moved to regulate swaps tied to natural gas and electricity prices, including those on the Intercontinental Exchange Inc., the second-largest U.S. futures market, and the Natural Gas Exchange Inc. in Calgary, Canada’s leading energy exchange. The House of Representatives passed legislation on Dec. 11 designed to shed more light on the $605 trillion over-the- counter derivatives market. The measure would exempt corporate “end-users” such as oil companies and airlines that use derivatives to hedge operational risk. Narrowing Exemptions Gensler has pushed Congress to narrow the exemptions and give the commission authority to curb speculation in off- exchange commodity contracts. “Until the CFTC has over-the-counter jurisdiction, they wouldn’t gain a whole lot from making tight, binding limits because moving to over-the-counter traders is an easy solution,” said William Hederman, senior vice president for energy policy with Concept Capital’s Washington Research Group. A lack of transparency in the over-the-counter market contributes to systemic risk, Gensler said in a Jan. 12 speech. “An opaque market, concentrated with a small number of financial institutions, contributed to a financial system brought to the brink of collapse,” Gensler said. Gensler has said that the exemptions may provide a loophole for financial institutions with end-user clients to circumvent the limits, saying in the Jan. 12 speech that “it is the Wall Street banks that benefit from the so-called ‘end-user exemption’ from transparency, not the businesses that use derivatives.” Commodity Businesses Commodity-based businesses such as manufacturers, airlines and energy producers that use derivatives would be exempt from the clearinghouse requirement if they can show they are using the contracts to hedge operational risk. The transactions would have to be reported to regulators. Gensler has proposed a three-pronged regulatory approach: regulate derivatives dealers, bring transparency to the OTC market, and move standard derivatives to regulated clearinghouses. He cited estimates that half of all commodity and energy derivatives transactions could be standardized.

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