Energy consultant James Wilson of LECG LLC’s Washington, DC, office said he agreed with FERC’s staff’s conclusion last week that there probably was gas market manipulation during autumn 2000 to early summer 2001. However, he believes staff provided no evidence for the additional claim that published price indices were inaccurate or manipulated. Also, Wilson said it would be hard to distinguish the impact of manipulation vs. price increases due to market forces (see Daily GPI, Aug. 15).

FERC staff based its recommendation to change the gas price mechanism used in calculating western power cost refunds during the period in question on its conclusions about potential price manipulation. Hearings in the power refund case are under way this week.

Wilson said the staff report “jumbled together two different criticisms they are making of prices at the time. On the one hand, they are saying that the market may have been manipulated and that market prices may have been higher than they should have been as a result of various factors and the trading strategies. And a second issue is whether the published indices reflected the market and were accurate. You could have prices manipulated in the market by withholding [supply or transportation capacity] and yet the published indices could very accurately reflect those manipulated prices.”

Commission staff cited “preliminary indications” that daily published spot gas prices at California points, used in its original calculation of the mechanism for refunds, may have been open to manipulation. It also claimed that market participants had an “incentive” to supply bogus numbers to the spot price publishers, since they may have had deals tied to the published prices.

“They have a lot of confidential data that we don’t know about that was reported to the trade press, so if they found some good evidence of manipulation that’s great,” said Harvey Morris, attorney for the California Public Utility Commission. “We applaud FERC staff’s efforts on this.”

However, Wilson concluded that staff has “jumped the gun on the doubts that they are placing on the indices…” If they have the evidence, they certainly don’t provide enough of it to support their conclusions, he said.

The staff report also noted there was little correlation between the border prices and the Henry Hub at the time, concluding that “the abnormally low correlation for this isolated period renders the prices at the California delivery points inappropriate for setting rates.” Staff suggested using published prices from the adjacent gas producing basins, plus transportation costs, as the gas cost component of the refund mechanism. The prices from the producing basins had a closer correlation with the Henry Hub during the period.

Wilson also noted that a lack of correlation does not necessarily indicate manipulation occurred. “The other thing that is surreal about this report is there’s no mention of the CPUC v. El Paso proceeding,” he noted, referring to the case in which El Paso Merchant Energy and El Paso Natural Gas are being investigated for their roles during this period in the high gas prices at the California border. “I understand the FERC staff may not want to go anywhere near saying anything about the resolution of that case, but there is an enormous amount of testimony in that case about what was going on in the market at this time.

“For instance, they criticize the indices for not correlating with basin prices, but there is a lot of testimony in that proceeding indicating that the times when the California prices split away from basin prices were exactly those times when the pipelines serving California were full or nearly full. That’s exactly when you expect those prices to separate…You just don’t expect there to be that correlation in a market that is under a fair amount of stress because the pipes are running nearly full.”

Morris also referred to the CPUC’s case against El Paso. What FERC staff addressed was “only part of the problem,” he said. “Another part of the problem was the withholding of interstate pipeline capacity to California.” FERC’s chief administrative law judge is expected to release his initial decision in the El Paso case at the end of this month. Morris said some of the same FERC staff that conducted the study also were witnesses supporting the CPUC’s belief that El Paso was withholding capacity and did not meet its certificate obligation. “The withholding of pipeline capacity made it that much easier for market manipulation to occur from other marketers,” said Morris. “If you withhold 700 MMcf/d to 1 Bcf/d of interstate pipeline capacity, there’s a lot less access for other marketers. At the end of the El Paso merchant contract in June 2001 and thereafter, prices to California plummeted.”

However, Wilson and others have noted there were a lot of other factors affecting the market at that time that also were hardly mentioned in the staff report. There was abnormally high gas and power demand, full pipelines, low hydroelectric supply, relatively low storage levels, almost no price-responsive load and California’s heavy reliance on old inefficient gas-fired power generation.

“November 2000 was the third coldest on record, and resulted in a succession of OFOs,” noted one marketer. “We watched the prices jump up with each one, starting at $7 and going up to $16-17 by the end of the month. While concerned, we felt that this was not all that unusual, given there was little unaccounted for supplies, but large incremental demand due to the weather. We expected that everything would settle down during bidweek when the normal first-of-the-month supply pools became available. Wrong! Prices opened at $12, and reached $17 by the end of bidweek.

“There was a general shortage of supply versus demand, and Enron with [its] financial muscle and [EnronOnline] took major advantage of it,” the marketer noted, touching on a major concern of FERC staff. “They ramped up their buy and sell prices through bidweek and everyone followed. During December, they got day prices up to almost $70. The only thing that stopped them in their tracks short of $100 (which we heard was the subject of bets on the Enron trading floor) was again the weather. We went from the third coldest November here in California to the third warmest December.

“On the second Monday, they opened EOL at $69.95 for California points and within a half hour, they dropped to $35 and then disappeared for the day early. The guessing was that their traders in Houston were not following the weather out here,” he said. “The weekend had been very warm, which resulted in the LDCs dumping back system supply into the market on Monday. I wonder how much gas Enron bought at $70 before they realized no one wanted it or needed it!

“NGI was not manipulated in reporting the market — [it] accurately reported what took place,” the marketer said. It was the market itself that was manipulated, he said.

LECG’s Wilson noted that market observers have been claiming market manipulation for a long time. Many fingers have been pointed at Enron’s market power through EnronOnline (see Daily GPI, Sept. 13, 2000 ). There also have been long-simmering allegations that some electric generators actually benefited from higher prices because they were buying gas from affiliates and could pass the gas price through to customers under the regulations at the time. The issue of whether the California border gas prices are the right mechanism to use to calculate refunds also is not new. But whether FERC should use basin prices instead is up for debate.

“It’s very difficult to determine what the price ‘should have been’ given that the pipes were full or nearly full,” said Wilson. “I agree with those who say that prices were manipulated and were higher than they should have been, but it’s very hard to determine how much of the price increase was due to constraints and would have been there in a more competitive market and how much was due to the actions of various parties, whether it’s El Paso, EOL or someone else under the circumstances,” said Wilson.

When the gas pipeline system is constrained, it causes prices to rise and it also creates a situation where the system is highly vulnerable to attempts by sellers and traders to make the prices rise even more, he noted. Even a small amount of withholding under those circumstances can make the price rise sharply. Demand was very inelastic at that time; there were few customers able to reduce consumption when the prices rose. The electric generators had a crisis situation and had to continue buying.

In addition, there was very little gas in storage at the time because many non-core customers had drawn down their storage expecting prices to be lower in the winter, and because of the El Paso mainline explosion they were not able to refill. Given these circumstances, a company with substantial power in the market has an even greater opportunity to move the price of gas. The industry publications merely reported the transactions that took place during those unusual circumstances.

“I must confess, the [staff] report and its recommendations leave me torn,” said Arthur O’Donnell, editor of the industry publication California Energy Markets, in an editorial this week. “On one hand, I am heartened that federal regulators are beginning to make the connection between the gas-price explosion of late 2000 and its effects on the electricity market. On the other hand, I am seriously concerned that FERC staff appears to be seizing upon the simplest explanation for a complex phenomenon. As we are all too painfully aware, basing a solution on a flawed analysis will only cause further problems.

“I am very concerned that the long-term impact of the FERC report could be to undermine one of the most necessary features of a competitive marketplace — independent price discovery and market transparency afforded by non-regulatory reporting services.”

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