Ever since Enron crashed and a wave of related negative events came down on the gas industry, there have been concerns about the health and even the fate of the gas spot market. But trying to take the spot market’s pulse isn’t easy. In fact to do it with any accuracy is darn near impossible, according to several market experts.

Numerous marketing companies have closed up shop or scaled down their trading. It’s widely known that gas trading volumes are down substantially, but because many former marketing giants, such as Mirant, American Electric Power, Duke Energy, Aquila, Dynegy and National Energy & Gas Transmission (formerly PG&E National Energy Group), no longer report gas sales volumes to the Securities and Exchange Commission — in part due to the wash trading scandals — it’s difficult to get a handle on how far third quarter sales volumes of the top gas sellers declined. Even knowing that, however, would fall far short of determining the market’s health.

Consultant Ben Schlesinger had been compiling a directory of gas marketing firms for years but last fall had to discontinue the project indefinitely. “We made a major commitment to it a few years ago, but then came security issues because of 9/11, credit problems set in and clammed companies up and then with the scandals, they just wouldn’t talk at all. After about four months, we got reasonably good data on about 13 companies. We used to get data on 300 companies. Now there’s regulatory scrutiny, legal scrutiny, internal company scrutiny.

“Just speaking with people we sense that [the gas market] is recovering,” said Schlesinger, who has had his own Maryland-based energy consulting firm for 20 years. “We’re seeing some new faces in the market business. Major oil and gas producers are clearly in there now. There are a handful of survivors: Sempra, Coral and a few others. Credit is a real issue.”

But according to Schlesinger and to Scott DePasquale of Boston-based Energy Security Analysis Inc., it all really boils down to market liquidity.

The futures market remains extremely liquid. Although there was a decline last year in futures contracts to about 19 million from 25 million the prior year, it was still the second highest annual volume ever.

“Nymex is enormous. If you multiply the average volume last year by the average price, it’s over $1 trillion worth of gas that changed ownership,” Schlesinger noted.

While that’s a clear sign of health, there have been concerns about — and calls for investigations into — high futures prices and volatility. There’s no doubt that the composition of the players in the Nymex gas pit has changed. Enron and the other mega marketing firms are gone. Looking at the Commodity Futures Trading Commission’s Commitments of Traders report, it’s clear that the market share of commercial traders has dropped, while the market share of non-commercials, the speculators and hedge funds, has risen over the last few years.

“These hedge funds now more than ever have a bigger impact on Nymex prices and as a result there has been greater volatility,” said DePasquale. “But if you pull the hedge funds out, it’s going to be a heck of a lot less liquid.

“This current situation could be considered unhealthy because in a perfect world you would have a balance between commercial trading activity and financial players,” DePasquale said. “But also keep in mind that part of this market volatility is due to uncertainty about the fundamentals in this market. You can’t discount what is happening with supply.”

Looking at the Nymex, with its decreased commercial participation and increased volatility, you could make the argument that it also is happening in the cash market. But without good spot market data, there’s no way to test that theory.

It’s hard to research the cash natural gas market where, as in most competitive product markets, there is no deal repository, no paper trail.

“If you are trying to look at the characteristics of trading in the cash market, that’s tough,” said DePasquale. “The problem is that it’s all over the counter [OTC]; there’s no central clearinghouse. I think it would be really an accomplishment if anyone got their arms around it.”

In order to determine what is happening in the cash market as a whole, all the data embedded in all the OTC transactions would have to be collected and analyzed.

“Currently there’s no way to tell whether there is more trading taking place in the daily market or the baseload market, or whether liquidity in a specific pool like the Houston Ship Channel is getting bigger or tighter — and if it’s getting tighter, where are people getting their gas now and why,” said DePasquale.

“When I was a gas trader and traded cash in a place like [Texas Eastern] M-3 in the Northeast, I got a sense everyday of who was doing what just from being involved,” he said. “You get a sense of those volumes, but trying to empirically test that is very difficult. I wouldn’t even really know how to start.

“You can get the actual gas flows through specific meters from the gas pipeline companies. You would have to start with developing a model of exactly how much was flowing through the meter every day during the month. Then you look at the swap pricing and overlay the prices on that and then try to back into how much gas traded through a polling exercise. That might be a logical way to develop a study,” said DePasquale. But it’s not exactly a simple undertaking.

While mandating price reporting may be the only way to get a complete answer to the question of how healthy the market is and whether the prices reported are representative samples, such a move by the federal government could cripple the market, said DePasquale.

“If you do that, you are going to put a huge constraint on the cash market,” he said. “FERC will actually make the market even less liquid by doing that. If companies have to report their positions, they lose a competitive edge. They also open themselves open to regulatory risks. When that happens, if there is a way for you to get out of that market, you take it.

“It’s not going to be a profitable market anymore with so many constraints on it,” DePasquale added. “That’s an inefficient marketplace. Folks will move their capital into trading other things. The speculators aren’t going to want it, and if you take speculators out of the market and you are just left with hedgers, you are left with a bunch of people all doing the same thing; you don’t have as much of a two-way market anymore. When there are no more speculators in a market, conventional wisdom tells us that markets collapse.”

Why should FERC take such a risk given the potential consequences? he asked. There are plenty of other signs of recovery and improvements.

Schlesinger, however, takes another tack. He is a strong advocate for mandatory price reporting in the spot market. He believes it would be good for the market and good for the industry, and he admits, as a consultant more data is good for his business.

“All the things that we believe should happen to make this market really recover, include deal memorialization on paper and even required reporting or with a FERC threat, thereof; that’s what we’ve been advocating, and I think the FERC has moved around to our thinking at least in terms of threatening to require data collection,” said Schlesinger.

“I do have a vested interest in FERC getting back into the [cash market data collection] business because it will give us a lot of data that we can analyze. But I think to reinstate Orders 319 and 234b, requiring filings within 30 days of each transaction would at least get the industry back into a data delivery mode, which they are not in now.”

FERC has pursued a cooperative approach so far regarding price reporting to index publishers, but there have been signs that it is headed in the direction of a mandate. The Commission soon will be surveying the industry once again to determine if there has been progress on reporting.

Schlesinger admits he was disappointed in 1985 when data flow stopped with wellhead deregulation and Order 436. “We used to be able to tell you the average deal size, region by region, time by time. It was very interesting data. To this day, I think about it, wondering what the average deal size is in the United States. The database had it at about 7,000 Dth/d.”

He believes more data would give the Commission more ammunition to address market problems. The CFTC has total oversight of the futures market because “individuals try to corner markets,” said Schlesinger. “There are unfair trading practices.”

Schlesinger is a strong supporter of Nymex, noting that the volume of basis swaps cleared through Nymex soared in 2003.

“Now they are doing as much in a day as they were doing in a whole month,” said Schlesinger. “It’s increased tremendously. This is being picked up by the industry. Many of the large points are pretty highly traded.”

Schlesinger also noted that the crude oil market has become aligned with the gas market like never before, setting the stage for the international community to come aboard with a massive influx of LNG imports.

“WTI crude is basically trading at summer gas prices. This has been going on for over a year,” said Schlesinger. “First that says there is a very high correlation between crude and natural gas prices on Nymex; I’m talking about a 96% correlation coefficient. The average R-square from 1985 to 2001 was 27%, which is approximately the correlation of oatmeal [to oil]. This does put [U.S. natural] gas kind of on the world scene.”

There is no government mandate requiring that. The world energy market is doing it, he noted. And this is giving the international energy community more and more confidence in Henry Hub natural gas. There’s a whole world focused on North American natural gas now.

“I think that this huge interest from the outside world will get the gas market healthy again, if it is still struggling along,” said Schlesinger. “That’s inevitable.”

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