“Excessive Speculation in the Natural Gas Market,” a 139-page report released June 25 by the United States Senate’s Permanent Subcommittee on Investigations, is a masterpiece of its genre. An account of the energy market shenanigans engaged in by the now-defunct hedge fund Amaranth, the report is well-written, extensively documented, and makes a dramatically persuasive argument: A broken regulatory system allowed Amaranth the leeway to distort natural gas prices, and the system needs to be fixed.

There are two major exchanges where contracts to buy and sell natural gas futures are traded; the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange, (ICE). But there’s a huge difference between the two. NYMEX is regulated, ICE isn’t.

ICE has no legal obligation to monitor trading, no legal obligation to prevent manipulation or price distortion, and no legal obligation to ensure that trading is fair and orderly.

Amaranth played in both venues, amassing enormous positions in natural gas futures while making billion dollar bets on the directions prices were headed. But when NYMEX regulators became nervous at the size of those bets, and ordered Amaranth to reduce its positions, the company just moved its action over to ICE, where there were no regulators watching over its shoulder.

Amaranth’s bets ultimately went sour and the hedge fund imploded. On Wall Street, the rise and fall of the hedge fund was seen as financial Darwinism in action. The fund got too greedy, screwed up, and now is gone. No one is shedding any tears.

But real people did get hurt. The Senate report convincingly demonstrates that Amaranth’s speculation pushed prices higher than the normal laws of supply and demand justified, which means that the cost of natural gas for end users who depended upon the fuel for heating or cooking, or for utilities who generate electricity from gas-fired power plants rose more than it should have. Brian Hunter, Amaranth’s chief energy trader, made bad bets, and your heating bill rose. That, ladies and gentlemen, is an example of “market failure.”

The Amaranth case history is not just the story of a single hedge fund dominating the market, but of a broken regulatory system that has left our energy markets vulnerable to any trader with sufficient resources to alter energy prices for all market participants.

Doesn’t seem right, does it? Blame Enron.

ICE is an electronic trading exchange. As far back as 1993, Enron started lobbying the Commodity Futures Trading Commission (CFTC) to exempt electronically-mediated energy trading from government regulation. Wendy Gramm, chair of the CFTC at the time, shepherded the exemption through, and then promptly quit her government job and took a seat on Enron’s board of directors. In 2000, the exemption, informally referred to as the “Enron loophole,” was codified in the Commodities Futures Modernization Act. The result: A state of affairs that the Senate subcommittee investigators justifiably call an “irrational” situation — a market that is half-regulated and half-unregulated.

The Amaranth case history demonstrates that the disparity in regulation of the two markets [NYMEX and ICE] prevents the CFTC and the exchanges from fully analyzing market transactions, understanding trading patterns, and compiling accurate pictures of trader positions and market concentration; it requires them to make regulatory judgments on the basis of incomplete and inaccurate information; and it impedes their authority to detect, prevent, and punish market manipulation and excessive speculation.

The details of the Amaranth meltdown have been well-reported and the survival of the Enron loophole is hardly breaking news. But if you’re looking for a compelling argument for why some markets should be regulated, “Excessive Speculation in the Natural Gas Market” is a seminal text. Because the lessons it teaches are relevant far beyond just the market for natural gas.

Trading of all kinds of commodities is booming.

Over the last ten years, commodities trading has exploded in U.S. markets. Trading volumes have quintupled to 3 billion contracts per year. The number of different futures contracts and options being actively traded has increased nearly sevenfold, from 179 in 1995, to an estimated 970 in 2006, to a projected total of 1,120 in 2008. An entire new energy commodities exchange, ICE, has been established and is now trading hundreds of thousands of contracts daily. Investments in futures commission merchant accounts have quadrupled, increasing from $33 billion to $137 billion. Investments in major U.S. commodity indices have grown more than tenfold, climbing from a combined total of less than $10 billion in investments in 2000 to an estimated $145 billion in early 2007.

But the best, (or worst) is yet to come.

Consider, for example, this sentence from a New York Times article published Friday describing the increasing popularity of carbon trading in London.

“Carbon will be the world’s biggest commodity market, and it could become the world’s biggest market over all,” said Mr. Redshaw, the head of environmental markets at Barclays Capital.

The implications of that statement are enormous. The goal behind carbon trading is to reduce greenhouse gas emissions, by providing a financial incentive to cut down on the production of carbon dioxide. Granted, there is plenty of disagreement over whether or not a carbon trading market is the best way to address climate change. Nevertheless, momentum appears to be gathering in favor of expanded markets for trading. So suppose that Mr. Redshaw is correct — suppose that carbon does become the world’s biggest commodity market. There is hardly an aspect of human existence on this planet that will not be affected by trading patterns in carbon markets. How energy is produced and consumed, how industry functions — the scope of such a market is so vast as to almost be beyond comprehension.

The temptation to game and manipulate such markets will be irresistible. The responsibility of governments to regulate will be immense. The lessons of Enron and Amaranth must not be ignored.