Hearings and Business Meetings

SD-366 Energy Committee Hearing Room 02:30 PM

Mr. Charles Carey

Chairman of the Board, Chicago Board of Trade

Testimony of Charles P. Carey
Chairman of the Board, Chicago Board of Trade
Before the Senate Committee on Energy and Natural Resources
June 19, 2006


Mr. Chairman and Members of the Committee, on behalf of the Chicago Board of Trade, I thank you for the opportunity to appear before you today.

Founded in 1848, the Chicago Board of Trade has a more than 150-year history of providing critical risk management markets and price discovery for a variety of industries.  Our experience in providing customers with open, transparent, liquid markets and our commitment to the integrity of those markets has allowed the CBOT to grow dramatically from its founding to become a global, publicly-traded exchange with a total volume of nearly 675 million contracts traded last year.  The CBOT offers open outcry and electronic trading of futures and options contracts on a wide variety of agricultural, interest rate, stock index and metals products.  Among our most recent offerings are CBOT ethanol futures contracts, introduced in March of last year, and we are pleased to be providing our world-class risk management markets and transparent price discovery to this growing and vital industry.

The CBOT commends Congress and members of this Committee for enacting policies to encourage research, production and use of renewable fuels in the U.S.  As you know, the Energy Policy Act of 2005 included a national Renewable Fuels Standard (RFS), which created a baseline renewable fuel use requirement of 4 billion gallons in 2006, increasing to 7.5 billion gallons by 2012.   The CBOT supported the establishment of the RFS, and believes its implementation will continue to foster development of the U.S. renewable fuels industry, ultimately establishing a more self-sustainable energy supply and providing a key source of potential revenues for farmers and rural economies in the U.S.

The rate of growth in the ethanol industry has increased dramatically over the past few years.  From its modest beginnings in the late 1970s to around 1980, it took over 12 years for the U.S. ethanol industry to reach an annual production level of 1 billion gallons.  A decade later, in 2002, the U.S. reached the 2 billion gallon annual production level.  It was at this point, however, that ethanol production truly began to accelerate.  It took just 2 more years to reach 3 billion gallons of production and only 1 year after that to reach 4 billion gallons of production in 2005.  Today, the U.S. ethanol industry has production capacity of approximately 4.8 billion gallons per year with nearly another 2 billion gallons of production capacity under construction. 

The Chicago Board of Trade began to study the ethanol industry in the spring of 2002.  At that time, the U.S. had annual ethanol production capacity of just over 2 billion gallons.  While many of our existing customers trading corn futures and options contracts supported development of an ethanol contract to enable ethanol producers to protect their processing margin in much the same way that soybean processors use soybean, soybean meal and soybean oil futures to protect their processing margins, the Exchange determined that the ethanol industry was not yet large enough to generate the liquidity needed to support a viable futures contract.  However, in our research, we learned some interesting facts about the ethanol cash market trade that prompted us to revisit the ethanol industry in a couple of years, when production and the size of the industry had increased.  Of particular interest, in 2002 we learned that the industry lacked reliable price discovery and viable price risk management tools.  At that time, ethanol price risk, if hedged, was typically hedged using Unleaded Gasoline futures.  That strategy worked in some instances but was problematic in others since gasoline futures prices did not always correlate well with ethanol cash prices.  Also, many new entrants to the ethanol industry were frustrated by a lack of reliable price data.  Most of these new entrants believed their product was priced fairly, but many were not certain. 

Part of the Board of Trade’s mission is to provide transparent risk management tools of the highest integrity, and to provide a price discovery mechanism and disseminate publicly the prices at which transactions occur on our exchange.  Therefore, in 2004, the CBOT reexamined the feasibility of an ethanol futures contract.  By that time, annual ethanol production in the U.S. had increased to above 3 billion gallons.  The U.S. still did not have a viable risk management tool or a transparent pricing source for domestic ethanol producers and users.  Moreover, U.S. market participants were even more enthusiastic about obtaining these tools than they were in 2002 since the additional production naturally created additional risk.  The Chicago Board of Trade designed a corn-based ethanol futures contract in 2004, and launched it for trading in March 2005.  The exchange offers the ethanol contract for trading both via open outcry and electronically on our e-cbot platform, and we now have more than a year of successful delivery cycles in the contract under our belt.

The CBOT Ethanol futures contract has demonstrated steady growth over the past year.  Today, market participants have open interest positions in CBOT ethanol futures contracts going out one year into the future and representing over 24 million gallons of ethanol.  Average daily volume, while variable, continues to grow.  More importantly, perhaps, the industry has begun to use CBOT Ethanol futures prices as a barometer for domestic prices.  By disseminating the prices discovered through transactions on our exchange, the CBOT is providing the industry with transparent pricing for the first time, and the results are encouraging.    Since all market participants now have a reference for pricing, the way ethanol is traded in the cash market has evolved as well.  Having a pricing benchmark has enabled the development of more varied and flexible cash contracts that have readily been available in the U.S. grain and energy markets, but have not been available in the ethanol market until recently.  The end result of these developments is more efficient trade that results in both higher prices for ethanol producers and lower prices for ethanol blenders (i.e., a tighter bid-ask spread). 

The Chicago Board of Trade held an ethanol industry meeting in early June to gather feedback from market participants representing both the buy and sell sides of the ethanol market.  Over 40 market participants came to Chicago to offer their support and ideas to grow the CBOT Ethanol futures contract.  They know that for their industry to continue to grow, greater efficiencies in trade will need to be realized.  They also understand that a transparent and fair futures market plays in important role in developing these efficiencies. 

We at the CBOT are proud of our part in this dynamic industry, and we look forward to its continued development.  Once again, we appreciate the opportunity to participate in this dialogue. 

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Forward Looking Statements
In this release, our use of the words “may,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or other comparable terminology is intended to identify forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. More detailed information about factors that may affect our performance may be found in filings made by CBOT Holdings, Inc. with the Securities and Exchange Commission, which can be obtained at its website at
www.sec.gov.  We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.