Publishers: Lack of Liquidity a Serious Problem for Gas Market

The biggest issue in natural gas price reporting today is the lack of liquidity, or low level of fixed price trading in the monthly market due mainly to the loss of the middleman marketers, price survey publishers told attendees at GasMart/Power 2003 Wednesday.

Larry Foster, Platts editorial director for natural gas, and Mark Curran, NGI's managing price editor, emphasized the seriousness of the situation, pointing out that it leaves an already high volatility market subject to even greater volatility. The remaining participants in the market are going to have to step up to the plate. "The solution to liquidity must come from industry. This is something the publishers can't solve," Foster said. The two outer ends of the market have been accustomed to pinning their transactions on the published indices, which in the past were in large measure set by the middle man trading sector which did the fixed price deals.

Both Foster and Curran said that reports of baseload fixed price trades have increased from their low point last November, but have not reached a "comfort" level. Foster said they had seen indications from producers and distributors at the recent conference on price indices at the Federal Energy Regulatory Commission that they recognized the need to become more involved in the market. Curran said, however, that LDC representatives had told him they were forced to index transactions because their public utility commissions judged their purchases and approved the pass-through of costs based on how close they came to Nymex or published indices.

The quality of the data publications are receiving is vastly improved due to the efforts of the Committee of Chief Risk Officers (CCRO). Virtually all data is coming in at transaction level and about 75% of it is submitted by a back office," Foster said. The reliability of the data is yesterday's problem, Curran added, advising that in the current atmosphere it is unlikely anyone would be submitting false data. It could become a problem again in the future, but right now the major concern is the number of fixed price trades.

Due to the efforts of the CCRO, traders who dropped out of the survey when the noteriety surrounding false reporting first flared up, are again reporting prices, the publishers believe. Both publishers said they are signing confidentiality contracts or letters of understanding with those doing trades and providing data.

Steve Harvey, a deputy director with FERC's Office of Market Oversight and Investigations, who also was on the panel, said he is aware of the need for more trading activity. He pointed to a filing made by the Intercontinental Exchange, which claims that about 70% of the daily market trades on its system. ICE reported that from January through April 25 of this year at the most liquid points an average of 21 trades by 14 companies, trading a total volume of 125 MMcf/d set the market prices. At the most liquid point, the Henry Hub, an average of 30 companies, doing 72 trades totalling 630 MMcf/d set the price. At the least liquid hub, five companies doing five trades set the price.

That means that about 100 trades a day by 40 or 50 firms across all the hubs set the prices. "That's less than 3% of delivered gas on a daily basis is setting the prices." Even if that only represents daily trades, "that's pretty low," Harvey said. And actually, the publishers pointed out, the daily market is not the problem. It's the monthly or baseload market, where the bulk of gas trades, that the liquidity is worst.

While "we need more trading activity, you have to realize there are a large number of customers who are not capable of trading," Harvey said. With the very tight gas market predicted over the next year which could put a great deal of pressure on the system and is likely to increase the price volatility, Harvey questioned whether the price reporting system "is durable enough given what we're facing."

Ellen Beswick, NGI publisher, echoed Harvey's concerns about the dangers inherent in a shortage market and urged market participants to work now toward doing more fixed price trading....possibly working up to doing as much as 20% of their business as fixed price trades -- and reporting them to the publications. Foster and Curran will be taking the message to the LDC Forum coming up in Atlanta in early June and also will be seeking a hearing at the summer meetings of the National Association of Regulatory Utility Commissioners.

For the longer term, Harvey said FERC is looking at three different models of price discovery: (1) fixing the current indices process; (2) getting more input from exchanges; (3) setting up a third party solution such as a self-regulating organization (SRO), such as Nymex, which operates under the guidance of the Commodity Futures Trading Commission (CFTC).

The published price indices have worked "relatively successfully for a long time," it's what the market is used to and comfortable with, but he is concerned whether they can handle about the increasing volatility in the future. Also, because of the First Amendment protections claimed by the publications, regulators do not have access to the data.

The available exchanges are ICE, which mainly records daily prices, and Nymex, which sets a price only at the Henry Hub. Harvey said the SRO model is interesting, but FERC currently doesn't have the authority to set one up, although some parties are lobbying the Senate, which is formulating its energy bill, to include authorization in the legislation. The idea "needs more research; I don't think they have a spotless record," Harvey said.

Foster had a long list of reasons why an SRO was unlikely. An SRO would offer no benefits in an illiquid market, since it would not be able to use secondary information such as relationships, bid-ask and derivative information to set prices at illiquid points, the way publications can. For it to work would require congressional authorization for mandatory reporting which is opposed by major market participants. "Funding would be a challenge...and transition to an SRO from the current system likely would be long and costly, a concern to the financial community."

In addition Platts said an SRO would likely be a monopoly picked by FERC. "We think there should be competition in price reporting," and both Commissioners Pat Wood and Nora Brownell have said they weren't interested in picking a winner. He questioned the ability of an SRO to scrub and polish the data in a timely manner and said publishers would have difficulty disseminating the information given to them by the SRO which they couldn't verify.

Beyond that, it's about time the market and FERC realized "there is no perfect gas price," Foster said. He urged "everyone to focus on what is doable in an imperfect market."

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