A group of attorneys general from the Midwest has reviewed the operation of natural gas markets and found "...that a complex spiral of factors has been driving [natural gas] prices to unprecedented and unjustified levels" and "the most troubling aspect of natural gas trading is that policymakers really cannot decipher what goes on...."
The report says that winter heating bills in the Midwest this winter are projected to be up by $250 per household, or 28%, compared to last winter. This is despite a 5% decline in consumption. "They are up over $600 compared to five years ago," the report says.
"If we do not look behind the half-truth, half-hype smokescreen of the headlines, consumers will continue to pay a lot more for natural gas than they should," the report continues. "The public discussion must be expanded to include the other factors that have been powering the upward ratchet of natural gas prices since the start of the 21st century. We must do this not simply because high prices are harmful but also because specific policy mistakes made in the past have helped to cause the current problems."
The 112-page report prepared for the Midwest Attorneys General Natural Gas Working Group by Mark Cooper, research director for the Consumer Federation of America, maintains gas markets have given consumers the short end of the stick, traders -- particularly hedge funds -- are largely to blame, and regulators have been ambivalent to the harm done to consumers.
"Econometric analyses of the natural gas markets in recent years raise important questions as to how well the natural gas markets work," the report says. "Given the uncertainty about the functioning of these markets, the claim that the market price is always 'right' because it is the market price should be questioned..."
That position stands in direct opposition to the market view espoused by Commissioner Sharon Brown-Hruska of the Commodity Futures Trading Commission (CFTC). She has voiced opposition to House bill HR 4473, passed by the House in December (see NGI, Dec. 26, 2005), which would require greater CFTC scrutiny of energy markets through increased surveillance and reporting requirements.
"As economic fundamentals change, markets reflect the changes through price movements, and there is never a shortage of individuals or interests that believe that such movement reflects market abuse or manipulative behavior," Brown-Hruska said at a recent energy conference in Houston (see NGI, Jan. 30).
The attorneys general report finds no shortage of blame. The first of many illustrations in author Cooper's report is a spiral diagram that attempts to illustrate the causes of high and volatile natural gas prices. The spiral begins in the "physical market," advances through the "financial market" and then reaches "regulatory institutions." Along the way, blame is deposited at every turn: mature resource base; inelastic demand; inflexible transportation and storage costs; sluggish investment restricts capacity; speculators increase volatility, risk; thin long-term markets; short settlement period, large positions; press reinforces high-price psychology; misalignment of short-term incentives and long-term needs; regulatory risk aversion.
"Tight markets reflect public policies and strategic behaviors, not just Mother Nature," the report maintains. "To the extent that Mother Nature is a wild card, policymakers can and should create systems that are less vulnerable and better able to mitigate the impact of supply shocks.
"The incentive structures and distribution of bargaining power in the physical and financial markets for natural gas are unnecessarily tilted against the consumer. Public policy can and should ensure a better balance."
The American Public Gas Association (APGA), long a critic of high gas prices and gas markets, was quick to praise the report last week. "While increasing supply remains a fundamental component of the solution to bring natural gas prices back to an affordable level, there also needs to be greater focus on natural gas markets and how they function, particularly in terms of transparency," said APGA CEO Bert Kalisch. "In order to instill consumer confidence in the market, it is critical that a level of transparency exist that demonstrates to consumers that market prices are not being manipulated."
It should come as no surprise to major producing companies -- who only recently dodged the windfall profits tax bullet fired from the gun of high gasoline prices -- that they come in for criticism for natural gas prices as well.
"The position of the major oil companies with large holdings of natural gas physical assets, dominance of natural gas marketing, and active involvement in natural gas financial markets poses a serious threat to consumers," the report says. "Inadequate investment in exploration over the course of a decade or more contributed to the tight supply conditions. The massive windfall of cash flow in recent years dulls the incentive for the majors to supply gas to the market. They can keep it in the ground and hold out for higher prices. They are under no pressure to sign long-term contracts, except at extremely high prices. As major marketers and traders, they can move markets."
The report does not speak charitably of hedge funds either.
"When hundreds of completely unregulated hedge funds trade hundreds of billions of dollars (perhaps as much as a trillion dollars) of natural gas futures, without ever taking delivery of a single molecule of natural gas, it deserves some attention too, but this activity is hidden behind a veil of secrecy in unregulated hedge funds and trading in over-the-counter derivatives markets."
This view contradicts the position of the New York Mercantile Exchange articulated in a report issued in March 2005. The controversial report, which came in for its own share of criticism, said the influence of hedge funds on the gas markets was minimal (see NGI, March 14, 2005).
A PDF copy of the report is available by following a link on this page: http://www.iowaattorneygeneral.org/latest_news/releases/mar_2006/Natural_Gas.html
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