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Energy Risk & Markets

Allowance trading needs oversight, but don’t overdo it.

Fortnightly Magazine - July 2008

to take enforcement action against Amaranth even though Amaranth’s activity was in the futures markets. FERC argued Amaranth’s activities related to the NYMEX natural gas futures contract adversely impacted the physical markets because natural gas futures contract prices serve as a significant benchmark for prices in physical natural gas. FERC’s action has made it difficult for market participants to understand where FERC’s exclusive jurisdiction ends and the CFTC’s exclusive jurisdiction begins. 8 Worse, it’s created in-fighting between the two agencies. 9

The Feinstein-Snowe bill runs the risk of enabling the same turf battle to occur among the CFTC, FERC and the EPA related to emissions-allowance trading. First, FERC’s expansive interpretation of its enforcement authority might cause it to believe that any emissions-allowance manipulation is sufficiently connected to wholesale power or natural gas to give FERC jurisdiction. Second, notwithstanding a provision stating that the bill would not abrogate the CFTC’s jurisdiction, the bill still would give the EPA authority over markets that have long been within the exclusive jurisdiction of the CFTC ( i.e. , futures). For example, the Chicago Climate Exchange and NYMEX already offer emissions allowance futures, options and swaps contracts subject to CFTC oversight. Third, the bill does not make the EPA’s jurisdiction exclusive. The Senators might want concurrent jurisdiction to ensure no manipulation slips through the cracks. However, to remove the potential confusion and wasted compliance costs created by dueling agencies, it would be more productive to make it clear that only one agency has anti-manipulation authority over the emissions-trading markets. That agency should be the CTFC. Which leads to the next question: Does the EPA have the expertise to enforce the law? Again the answer is no. The EPA has substantive expertise on environmental issues and the SO 2 allowance program it administers. However, understanding environmental compliance is only one piece of the puzzle. Understanding how markets work is at least as important, and the EPA hasn’t proven itself particularly apt in this regard. The CFTC appears to be better equipped to regulate the emissions trading markets. It understands the defined markets ( i.e. , real-time, forward, futures, and options), and is experienced with the trading platforms on which allowances trade ( e.g., NYMEX, CCX), including as a regulator of SO 2 futures and derivatives trading today. The CFTC has an enforcement staff that could be trained to cover U.S. GHG emissions-allowance trading, while the EPA does not. The CFTC also has cooperation agreements with foreign regulators that would help address the international nature of the emerging carbon markets. Finally, the CFTC is familiar with at least some of the industries that will be covered, including the energy sector. So bringing the CFTC up to speed appears to be the easiest, most logical solution.

Should Congress give more than one federal agency enforcement authority over manipulation of the emissions allowance markets? No, only one agency at a time should be regulating emissions-allowance activity. It might make sense for the EPA to have enforcement authority over fraud and manipulation that occurs during the process it would follow to assess