Attempt to Close Enron Loophole Didn't Stop Oil's Price Rise, But It Did Kill LNG Prices

In 2008, then-President Obama pushed to close the Enron Loophole—the exemption in commodities trading law of certain types of energy futures from oversight by the Commodity Futures Trading Commission (CFTC)—that he claimed was enabling oil speculation and driving up gasoline prices. Obama lamented how the unregulated market of the Over-the-Counter (OTC) exchanges were being used to manipulate prices and drives prices skyward.

The 2008 Farm Bill would ostensibly close the Enron Loophole that enabled those markets, and oil prices would immediately drop following the bill’s passage in May of 2008.

But those prices soon swung back the other way and kept climbing for another five years—from 2009 until 2014, making it appear that the loophole wasn’t really closed in the way some had hoped it to be. Oil prices would continually climb through 2014 to almost $120/barrel in 2014, almost three times what they were a decade earlier in inflation adjusted dollars.

It wasn’t until six years after the loophole was closed, in 2014, did prices drop and stay that way. The cause of the price drop is not well established but generally associated with the growing supply of U.S. oil from the Baaken formation, declining consumption in China, and a stronger U.S. dollar.

Natural Gas Prices Collapse

While oil prices ignored the closure of the loophole, gas prices moved immediately and decisively downward after the elimination of the Enron Loophole, far below international prices, alongside a swell of production from fracking and increased exports to Canada and Mexico.

Gas prices at the Henry Hub—the main distribution hub in Louisiana that is the pricing point for natural gas futures on the New York Mercantile Exchange (NYMEX)—would immediately collapse in 2008 following the bill’s passage, going from a historic high of $9 per million Btu to around $4 a year later.

International prices for natural gas have also fallen, but only more recently, since 2014. When the U.S. LNG prices dropped starting in 2009, Asian and European market prices were at relative highs that year, and increased through 2014.

The Japanese Ministry of Economy, Trade and Industry show spot prices for natural gas dropping by a fourth or even an eighth from what they were in 2014—around $18.3/MM-Btu. Other foreign prices for LNG have followed a similar trend: far higher prices than at the Henry Hub.

Demand for natural gas surged internationally over the last 15 years, largely driven by growing demand from China. According to U.N. trade data, China imports over $34 billion more in natural gas in 2018 than it did in 2010. In 2006, natural gas imports to the country were almost non-existent. International imports of natural gas by weight are up by over 8,000 percent despite a lack of consistent reporting.

Affect on the Swaps Markets

Closing the Enron Loophole in the 2008 Farm Bill would effectively make unregulated OTC markets subject to CFTC regulation. Only bilateral exchanges between two parties that don’t involve multiple parties bidding would still be exempt.

And soon after it was signed, trading on the OTC markets would level off for most swaps and options (although not forward rate agreements). Futures markets like NYMEX would see a flood of trading, particularly in gas futures.

The Amaranth Example

A 2007 investigation by the Senate committee on Homeland Security and Governmental Affairs would investigate the involvement of one energy trader, Amaranth Advisors LLC, on the price of natural gas through its speculation in futures markets enabled by the Enron Loophole.

The report highlights how the hedge fund, whose investments at times represented 5 percent of the natural gas market, drove up natural gas prices with bidding on swaps in the Intercontinental Exchange (ICE) exchange—a large international OTC market. Communications between traders at the time would highlight how the company’s trades weren’t possible on the regular exchanges like NYMEX.

While the trades were lucrative for the fund for a time, their fortune would swing the other way as prices dropped and the fund would go out of business. The fund lost approximately $6 billion in natural gas futures contracts in a matter of days as the market turned against them.

Amaranth would eventually sue J.P Morgan for helping scuttle a deal to sell a portion of Amaranth’s portfolio to Goldman Sachs worth around $2 billion of the company’s losses around that time. Many of Amaranth’s employees would go on to work at Goldman Sachs soon afterward.

Enron, Its Loophole, and the OTC Energy Markets

The Enron loophole is, of course, named after the energy company that lobbied for its existence as part of the Commodities Futures Modernization Act of 2000. It enabled the company to trade energy derivatives such as swaps and futures in their own unregulated market, Enron Online, and it would enable the market for credit default swaps that would be part of the financial crisis in 2007-2008.

After the company fell into bankruptcy in 2001 following its accounting scandal, its online trading portal also disappeared, as did other online energy trading portals, like that of its energy rival, Dynegy.

Much of the energy trading done by Enron and Dynegy would move to the major banks like Citigroup and J.P. Morgan, which would set up energy trading groups in their own offices. Emails from Enron show that Enron even registered the website for Citigroup’s energy trading arm, citigroupenergy.com, in 2001.

Both J.P. Morgan and Citigroup would settle with Enron creditors and the Securities and Exchange Commission (SEC) for their role in enabling the account scandal that befell the energy giant. Other banks accused of assisting the company’s downfall included Barclays, Credit Suisse First Boston, Merrill Lynch, Royal Bank of Scotland, and Deutsche Bank.

Similar to the cases against Enron for its involvement in the 2000-2001 electricity crisis, the Federal Energy Regulatory Commission (FERC) would settle with a number of those same banks—J.P. Morgan, Barclays, Deutsche Bank—for other instances of manipulating California power markets years after the 2000-2001 crisis. According to Reuters, J.P. Morgan’s Ventures Energy Corp became an energy trading powerhouse following the acquisition of Bear Stearns in 2008.