Energy companies should not be regulated like banks

The Dodd Frank Act was intended to address the causes of the financial crisis of 2008 and put in place measures to ensure a similar calamity doesn’t happen again.  One area the law focused on was over-the- counter (OTC) derivatives, a contract that gains or loses value based on price movements of something else. Companies around the world use OTC derivatives to manage the risk that future prices will change in a way that makes doing business too expensive. For instance, using an OTC derivative an airline can lock in the price of jet fuel today, for fuel that it won’t actually buy for another year. This allows the airline to offer ticket prices today for flights that occur months later knowing that it won’t lose money if oil prices spike in the meantime.

Other users of these contracts include energy companies. Oil refiners, natural gas exporters and your local electric company all use OTC derivatives to manage risk.  In some cases these energy companies also offer derivatives to other businesses like the airline described in the previous example. However, energy companies and contracts based on energy are a tiny sliver of the business; as the Senators note in their letter, the overwhelming majority of the $600 trillion global market for derivatives is made up of financial contracts. Energy products are less than one-half of one percent of the global swap market, and five Wall Street banks control over 95 percent of the U.S. market for bank-traded derivatives.

ADVERTISEMENT
One of the causes of the financial crisis was purported to be the widespread use of OTC derivatives among banks and financial companies. As noted in the report of the Financial Crisis Inquiry Commission, the official body charged by Congress to investigate the causes of the crash, “the existence of millions of derivatives contracts of all types between systemically important financial institutions—unseen and unknown in this unregulated market—added to uncertainty and escalated panic, helping to precipitate government assistance to those institutions.” It was the web of connections among large global financial firms which led to U.S. taxpayers handing out over $800 billion in bailouts. No one has ever suggested that energy companies and their use of derivatives helped cause the financial crisis, and the taxpayers did not give these companies bailouts.

Thus it is curious that the senators state that by “failing to bring energy swap dealers under its oversight” the CFTC is losing the ability to prevent “systemic risk in energy markets”. On the contrary, imposing onerous bank-like regulation on nonfinancial businesses like energy companies is likely to have the opposite effect. It would drive these companies out of the swap markets and further consolidate the swap dealing into a handful of Wall Street banks that were at the center of the financial crisis.

Under Dodd Frank and the CFTC’s rules, swap dealers must hold money aside in order to manage the risk that their financial dealings will go sour, exposing them to loss. For a company like a bank, these capital requirements make sense—they limit the amount of risk that the firm can pose to the broader financial system. But in the case of a nonfinancial company with real assets, like an energy company that owns electricity plants, power generators, wind farms, millions of barrels of oil and the like, these requirements would serve only to take money that could be put towards investments in people and new technologies (including green technology) and idle it for nonproductive regulatory purposes. Swap dealers are also subject to extensive regulatory examination and customer margining rules which make sense for a bank, but would only cost jobs and innovation if placed on companies that provide goods and services like those in the energy business.

Calls to regulate energy companies as swap dealers are misplaced. Doing so would only further consolidate the business into a handful of banks, limit competition, eliminate customer choice and increase the type of systemic risk Dodd Frank purported to eliminate. Dodd Frank regulations borne out of the financial crisis shouldn’t fall on the backs of nonfinancial companies that, in many cases, were its victims.

Oxley is a former congressman from Ohio. He was chairman of the Financial Services Committee from 2001-2006.

More in Energy & Environment

Nike, IKEA join 221 companies in backing EPA’s climate rule

Read more »