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CFTC Advisory Committee Considers Alternative Energy Impacts on Derivatives Markets

bzwirb's picture
Commentary by Bob Zwirb

At a CFTC Energy and Environmental Markets Advisory Committee meeting, panelists described challenges that the diversification of energy generation resources (e.g., coal, natural gas, nuclear, oil and renewable energy) pose for the energy and environmental derivatives markets.

CFTC Commissioner and Committee Chair Dan M. Berkovitz stated that the energy market has "changed dramatically" in the past 10 years due to new technologies that have led to increased shale oil extraction and renewable energy. He noted that, as energy generation resources continue to diversify, further changes will occur in the physical markets that may then affect how derivatives are used to hedge risks arising from the physical markets. The panels discussed:

  • various renewable energy requirements set by state, federal and global regulations;

  • exchange-traded environmental derivatives contracts; and

  • the global energy transition to renewable resources and its effect on hedging risk using exchange-traded and OTC derivatives.

CFTC Chair Heath Tarbert stated that one of the agency's strategic goals is protecting the interests of "all Americans" in the regulation of the derivatives market. Mr. Tarbert said that several of the CFTC's "core agenda items" relate to the energy markets, including:

  • forthcoming proposed amendments to the position limits rule - exempting certain bona fide hedging - that would help energy producers, merchandisers and distributors better manage risks; and

  • a swap data reporting proposal designed to ease the regulatory burden and increase transparency in the energy swaps markets.

CFTC Commissioner Brian Quintenz defended the shale oil industry, criticizing the "significant threat" posed by the standardized approach for counterparty credit risk ("SA-CCR") proposal, which allows "advanced-approaches" banking organizations to use an alternative approach for calculating derivative exposures. Mr. Quintenz praised shale oil extraction for (i) helping the United States achieve energy independence and (ii) reducing carbon reduction by 2.3 billion metric tons. However, Mr. Quintenz warned that the SA-CCR proposal would penalize the industry by increasing exposure calculations related to oil and gas derivatives transactions. Citing an industry comment letter, Mr. Quintenz noted that the proposal would increase a bank's exposure calculations for a given set of transactions with a counterparty by up to 460 percent. Additionally, Mr. Quintenz criticized the proposal for not recognizing noncash collateral arrangements, which can be a way of managing the credit risk of certain derivatives transactions.

Commentary

Much of the discussion centered on the role of energy derivatives and regulation in dealing with environmental problems, including the “existential problem,” as Commissioner Behnam put it, posed by climate change, with views ranging from the highly prescriptive (Tyler Slocum of Public Citizen) to market-oriented (Commissioner Brian Quintenz who urged reliance upon “the vibrancy and liquidity of the American futures and swaps markets”). An interesting addition to the debate centered on two market participants—Daniel Scarbrough of IncubEx, and Richard Sandor of Environmental Financial Products, LLC—who described how mutually beneficial negotiations between the parties can be applied to resolving complex environmental problems without government intervention. (Based on the Coase Theorem of Property Rights.)

  

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