Regulation of Energy Derivatives

Publication Date: April 2006

Publisher: Library of Congress. Congressional Research Service

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Research Area: Energy

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Abstract:

After the collapse of Enron Corp. in late 2001, that company's activities came under intense scrutiny. Much of its business consisted of trading financial contracts whose value was derived from changes in energy prices. Enron's trading in these energy derivatives was largely unregulated: no information about the value or volume of contracts or the identities of traders in this market was available to regulators, except what was contained in Enron's own extremely unreliable financial statements. Trading in energy derivatives rebounded after a post-Enron slump, and much of the market remains unregulated. This "regulatory gap" strikes some observers and policy makers as dangerous for two reasons. First, the absence of government oversight may facilitate various forms of abusive trading and price manipulation. Second, the failure of a large derivatives dealer could conceivably trigger disruptions of supplies and prices in physical energy markets (though such effects were minor in the Enron case).

Legislation before the 109th Congress would require currently unregulated energy derivatives dealers to disclose certain trading data: S. 509 and H.R. 1638 (which applies only to natural gas contracts). Legislation to reauthorize the Commodity Futures Trading Commission (CFTC) -- H.R. 4473 and S. 1566 -- would increase penalties for fraud and manipulation. H.R. 4473 would in addition authorize the CFTC to collect certain market data from natural gas traders to aid in investigating manipulation. Some, including the CFTC commissioners, argue that new legislation is unnecessary because statutory authority to pursue fraud and manipulation already exists. This report summarizes the history and current status of energy derivatives regulation, as well as legislative reform proposals. It will be updated as developments warrant.