While natural gas trading is near the top of the market transparency chart, right behind equities and currencies, it loses points for price inefficiency because of the large amount of indexed transactions, according to a study sponsored by the Natural Gas Supply Association (NGSA). The study was done by Peter Locke, associate professor at the M.J. Neeley School of Business at Texas Christian University.

Trading constraints imposed on local distribution companies (LDC) by state regulators, who rubber stamp indexed prices because they represent an average, actually are ensuring that the market price does not reflect the true underlying supply and demand, said Locke in the report on “Natural Gas Transparency and Liquidity.” Because of regulatory policy LDCs stay on the sidelines and index rather than buy gas at fixed prices and risk having rates disallowed, he said.

NGSA is submitting the report in connection with an upcoming FERC technical conference on Transparency Provisions of the Energy Policy Act of 2005. The conference will run from 9:30 a.m. until 3 p.m. on Friday, Oct. 13. Natural gas industry representatives will offer suggestions and opinions in the morning, with electric market participants testifying in the afternoon. The Federal Energy Regulatory Commission is exploring its mandate on transparency in Energy Policy Act of 2005.

Some state regulators also frown on hedging by LDCs, which also constrains the futures market, Locke said. Because of the constraints on these major market participants the natural gas market does not fit the definition of an efficient market, which is one where the resource is extracted at the optimal rate and allocated to its highest valued use. An increase in efficiencies would decrease speculative trading, since that type of trading builds on inefficiencies.

“A reduction in trading restrictions will not only increase price efficiency, but would also tend to decrease speculative activity, since the inefficiencies which open the door for speculation will be lessened,” Locke’s report says.

The American Gas Association (AGA), representing LDCs, will have “a concrete proposal” to increase market transparency to offer FERC on Friday, Roger Cooper, AGA executive vice president told reporters at a Winter Outlook briefing Monday. Responding to questions, Cooper said the group will support market transparency, but he declined to reveal any more about the AGA proposal before the conference.

“There is something to be said that perception can be reality. If customers and regulators are not confident in the market, that’s a concern for our utility members. Whether it’s based on fact or not, it’s a concern. And, therefore, we need to address our customers’ concerns. And our effort has to be to ensure confidence in natural gas markets. So we will take steps to support measures that will increase confidence…Increased transparency will at a minimum hopefully improve” this, Cooper said.

Locke, meanwhile, defended the participation of pure speculators in the natural gas market, saying they added liquidity, ensured that trading partners would be available and created a smoother market with diminished price spikes by absorbing “information shocks” and the effects of large trades.

Because instant information on trades is available through the New York Mercantile Exchange and the IntercontinentalExchange and prices are measured daily by trade publications, the natural gas market is considered highly transparent, Locke said. This encourages participation in the market.

On the other hand, the gas market is not too transparent since the price indicators are anonymous and do not reveal traders’ names. A requirement for this kind of information, revealing company strategy and positions, could drive traders out of central markets.

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