Never since the fall of Enron have there been more calls for speculator witch hunts, more calls for new legislation seeking to disembowel evil energy price manipulators and more new regulations proposed (or issued) that are aimed at increasing market transparency or some such. In the last two weeks, the price of oil and the collective cry from voters about the price of gasoline has certainly fostered a new sense of urgency for lawmakers to “do something,” and soon.
New regulations and so-called “market transparency initiatives” issued by the CFTC last week, while perhaps associated with much of the crazy talk on Capitol Hill about the ills of market speculation, have so far not brought much of a negative response from the industry. In years past, when the FERC or the CFTC talked about “market transparency,” folks in the sector came to know it was a euphemism for “more regulations.” And as such, they saw red. Not this time. If they come out against market transparency measures right now, while Congress is in the middle of a witch hunt, market players seem to fear they’d be painting a big red bull’s-eye on themselves. Maybe, but probably not.
As PA Consulting’s Sid Jacobson has it, folks don’t seem to be coming out against the new CFTC rules because, well, the new measures may actually be a net positive for energy trading companies. Huh? What? Sure enough, he says, the additional market data that will now be required will eventually lead everybody to make better decisions on pricing and strategy generally.
“In the past couple years the big story has been, ‘Are the evil speculators out there driving up prices?’ And for the most part, regulators have mostly said, ‘No, we think the markets are fair and just, but let’s take a closer look in any case. Let’s strengthen monitoring anyway, as a sort of insurance.’ So I think the real underlying theme of these newly proposed market transparency measures is, ‘We really do need more reliable price discovery,’ particularly in long-dated curves.”
He thinks this new set of rules amounts to the CFTC finally conceding that the market needs to do a much better job with transactions that are happening on the long-date tenor “and we need to do a much better job of capturing the exposure in like-instruments that trade in different forums.” What he thinks they missed this time around, however, is that “there are also physical products that trade bilaterally, there are nonstandard look-alikes, OTC transactions that will never see the light of day, all these things I think need to be captured as well, if you really want to understand the size of the market.” This other stuff seems to play more into the issue of jurisdiction though, and we reckon will one day be corrected, but not now.
“When I was an energy trader and risk manager a few years back, and to this day as a consultant, I still get the same question from people, usually once a year: How big is the market? We do some rule-of-thumb, back-of-the-envelope calculations and basically take a guess. The reality is, nobody really knows what true open interest is. These new CFTC measures could go a long way in helping all of us answer this question. These new measures will force all of us to strengthen our reporting in the forward curves. And I think, why is this bad?”
Jacobson says if he were running a mom and pop E&P company or some major oil or gas concern, he’d essentially need to know the same thing to be successful: They need to understand their potential cash fl ow and earnings and they both need to understand the value of their portfolio, the liquidation, and the potential value of oil in the ground, their inventories. “Having transparency and better understanding liquidity on long-dated prices is, in this case, a true business enabler for these companies. It really gives companies more reliable data to do what they need to do: forecast cash fl ows, monitor collateral and credit exposure and project earnings.”
Jacobson agrees that this is perhaps why there has been such a limited backlash from the sector so far. A year ago, any calls for “more transparency” still had the effect of the bogyman calling. Then the credit crisis happened. “Today, as a consultant or as a businessman, adding reliable transparency to prices and depth of the market in long-dated curves is a tremendous net positive for anybody in this business. Now, we may have truly reliable data points… real apples-to-apples comparisons of future earnings and cash flows.”
The challenge right now, he says, is working this new policy through your enterprise so that you can actually benefit from the changes. “It will take time to filter, but if managed correctly, all companies can benefi t.”
Unfortunately, he says, many companies aren’t organized to take advantage of these changes. “The call comes in to the compliance department or risk control: Are you guys on top of this? They say, sure, and then go about getting their ducks in order. They read the rules. They speak to internal and outside counsel. They work up a spec sheet for traders, so they know what to do. But all the while, these companies are not connecting the dots. Because while all this is going on, there are also 50 people upstairs trying to reconcile last month’s P&L. And this same data that compliance or risk is playing with can make the job up in fi nance a lot simpler and more accurate.”
Not everybody will greet these new CFTC initiatives in such a positive manner. But with a little work, and we imagine a few juicy rationalizations, Jacobson thinks most folks will eventually come over to his way of thinking. Or, as more than one exec we’ve spoken to about this new transparency stuff put it, “It could have been much worse…”
By our measure, many of the new transparency measures are merely formalizing a lot of processes that were already in place, albeit informally, particularly on the international side of things. The same is true on some of the other points covered for the US markets. Some of this stuff isn’t exactly new.
“While that may be true,” Jacobson says, “if it’s practiced, it’s going to reduce costs for companies and make things more effi cient. If you do this right, you’re going to have more reliable, centralized data, which means you’ll have fewer fi re drills, less rule-of-thumb, less back-of-the-envelope calculations. Basically, I think you’re going to have more confidence in your numbers.”
Of course, one might argue that if you have good traders, you already have good numbers, right? “True,” Jacobson quips, “but not everybody has good traders… Morgan Stanley may have very reliable 10-year curves. But for every Morgan Stanley, there are 20 mid-market companies that still rely on the back of the envelope.”
Finally, he says these new initiatives may just improve another aspect of everybody’s trading operation, such that it might help many companies avoid the same sort of issues associated with the price index manipulation crisis of the post- Enron era.
“These new initiatives will increase the responsibility of the traders and the trading desks to account for and capture this additional data. It’s going to force more timely centralization of risk exposure and data introduction, and hopefully create more discipline, and even more useful data for price discovery and improving the performance of trading, and also the surveillance of trading.”
