Energy Market Manipulation: Definition, Diagnosis, and Deterrence
Pirrong, Craig, Energy Law Journal
Market manipulation is a contentious topic in all commodity markets, but especially in energy markets. Especially during the period of rapidly rising energy prices in 2006-2008, accusations that manipulation contributed to these increases were widespread.
Despite the salience of the subject, it is little understood. Indeed, there is substantial confusion about what constitutes manipulation. A good deal of this confusion is attributable to the fact that although there are in fact at least two very distinct categories of manipulative acts, these different categories are too often blurred. Specifically, some manipulations (like "corners") exploit market power, while others employ fraud and deceit. It is possible to execute a market power manipulation without engaging in deceit, and those without market power can engage in fraud-based manipulations.
Three federal statutes, the Commodity Exchange Act (CEA), the Energy Policy Act of 2005 (EPAct 2005), and the Energy Independence and Security Act of 2007 (EISA) all prohibit manipulation of various energy commodities and empower federal agencies to impose penalties on manipulators. Unlike the EPAct 2005 or the EISA, the CEA does distinguish between market power manipulations and fraud-based manipulations. However, a series of poorly-reasoned legal decisions have undermined the efficacy of the CEA as a tool for combating market power manipulation. The EPAct 2005 and EISA are both based on section 10b(5) of the Securities and Exchange Act, and focus on fraud-based manipulations. As a result, they are ill-suited to address market power manipulation, and attempts to use them to do so will inevitably lead to further legal confusions.
Market power manipulation is important, but it is necessary to revise existing laws to (a) distinguish market power manipulation from fraud-based manipulation, and (b) provide more specific guidance on what constitutes market power manipulation, and what types of evidence is sufficient to prove market power manipulation. In this article, I set out an economically-based approach to these issues.
Manipulation in financial and commodity markets is a hot button issue. Recent months have seen widespread assertions that derivatives markets have been rife with manipulation.
Nowhere have these accusations been more numerous or heated than in the energy markets. As oil and natural gas prices skyrocketed in mid-2008, allegations of manipulation rose with them. Although prices have declined, the pace of allegations has not. Moreover, concerns about manipulation have led to calls in the United States and world-wide for a far more intrusive regulatory system to reduce its prevalence.
Sadly, seldom in the course of human events, have so many been so confused about so much for so long as is the case with commodity market manipulation. What's more, U.S. legislators and regulators have definitely been a part of that "so many." The current statutes that address manipulation in energy markets - the Commodity Exchange Act, the Energy Policy Act of 2005, and the Energy Independence and Security Act of 2007 - and the regulations issued thereunder by the Commodity Futures Trading Commission (CFTC), the Federal Energy Regulatory Commission (FERC), and the Federal Trade Commission (FTC) - are often imprecise, and where they are precise, fundamentally wrongheaded. As interpreted by the courts and the CFTC, the CEA's anti-manipulation provisions provide large loopholes that permit those who engage in conduct an economist would consider clearly manipulative to escape unpunished. Moreover, a recent court decision challenges the very Constitutionality of these provisions in criminal manipulation prosecutions, and also raises serious questions about the efficacy of the CEA as an antimanipulation tool. The FERC and FTC anti-manipulation rules are newer, and have not been extensively tested in litigation, but from an economist's perspective, these rules (and the statutes that authorize them) are completely misguided and hopelessly ill-suited to reach the kinds of manipulative conduct most likely to occur in energy markets. …