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Electronic Experts Debate Auction Process

Electronic Experts Debate Auction Process

While gas industry officials debated the merits of capacity auctions, electronic trading experts last week indicated such auctions were doable from a technical standpoint but would first require a certain amount of standardization of products, definitions and practices. This immediately raised the eyebrows of some critics, who believe that too much standardization could be harmful to the gas industry.

In designing an auction system for the gas market, "the whole key is how do you attract liquidity because liquidity is what makes everything happen. To get liquidity, you have to make a product look like a fungible commodity - which means common definitions and deadlines, and few if any restrictions or exceptions," said David G. Hanson of Quicktrade L.L.C., which is owned by Dynegy Inc., Sempra Energy and Nicor Inc. "The system must also be easy to use, and it has to be integrated with EBBs in the back [office]. And it must be a multi-pipeline system, not just one pipeline at a time."

The common deadlines/definitions are needed for both capacity and commodity. "I still think we got a long way to go before we get to a fungible product [in] capacity. But if there's a will, I think we can get there," Hanson said at the second FERC staff conference on auctions last Tuesday. "You need to be able to trade the entire path. If you're buying in the Gulf Coast and selling in Chicago, you have to be able to buy that entire route even if it crisscrosses two to three pipelines, and you have to know you're going to get the whole thing. You need to have single entry so you don't have to re-load all the information. And to get all this, you also need common definitions for firm, IT." In fact, the "more each pipeline has common definitions for firm, for interruptible, for how you treat capacity going through a pool...across multiple pipelines, the better it is," he noted.

"It shouldn't come as a surprise that we think some things should be standardized" to carry out auctions, said Greg Lander, president of TransCapacity. But Robert A. Levin, senior vice president at the New York Mercantile Exchange, believes the drive toward standardization could be a "double-edged" sword for the gas industry, possibly stifling flexibility and creativity in the process. "How are you going to let those thousands of flowers bloom [in the market] and whose going to cultivate them?" he asked. William Boswell, vice president and general counsel for Peoples Gas, raised concerns about the standarization of capacity. "It's flexibility in capacity contracting that's necessary for the current market, not standardization of capacity as product."

Rusty Braziel, chairman of Altra Energy Technologies, told FERC staff that his company has seen both the "good side and the bad side" of electronic auctions. Three of its electronic systems have been commercial successes, while one - Capacity Central - "withered up and died away" for a couple of reasons, including sellers favored the gray market when they had the opportunity and buyers opted for pre-arranged deals to avoid the transparency of auctions.

"We don't believe Capacity Central's failure had anything to do with a lack of market demand for electronic capacity trading. Instead, this experience taught us two primary lessons: 1) to be successful, electronic trading services must closely replicate the workings of a traditional phone/Fax-based marketplace; and 2) the electronic auction provider must be able to adapt quickly as the market makes its preferences known. The only way to know that is to put something out there, and give the people value and service enough to pay for it."

Both Altra's Braziel and Quicktrade's Hanson agreed that a capacity auction in the gas industry should be handled by third-party auctioneers as opposed to individual pipelines. "A third party keeps things anonymous, keeps it unbiased, keeps a level playing field, and all this together helps eliminate market power," Hanson noted.

If the Commission "allows and encourages" the development of third-party auctioneers for gas capacity, Braziel predicts that about two to four competing systems would evolve. He believes this would be far better than having "80 different pipelines implementing 80 different systems."

The two also concluded that a two-sided auction (with best bids and offers being matched) would be more suited to a capacity auction. Two-sided auctions are "much more efficient and will attract the most players, and we've seen that on the gas side. Basically on one screen you could have electronic trading of [the commodity] and of the capacity. And to the other side, the traders will eliminate any of the inefficiencies in the prices. And with an on-line credit system tied into this, nobody would be able to purchase anything outside of their own credit limits," Hanson noted.

But Jeffrey Holligan of Amoco Production said he preferred the single-sided auction. "...[W]e do believe that clearly single-sided auction of pipeline capacity would lead to lower transaction costs for us on a daily basis."

Susan Parker

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