The natural gas market is ill but the illness is “manageable,” FERC’s Office of Market Oversight and Investigations (OMOI) said last week in its first analytical report to the full Commission. The OMOI cited five major conditions currently draining the health of the industry, including deteriorating financial conditions of market participants, credit exposure, shaken confidence in price discovery methods, the need for infrastructure investment and the continuing potential for market manipulation.

The last item on the list is one of the most significant concerns and perhaps the only one FERC is capable of addressing, FERC Chairman Pat Wood noted in receiving the OMOI’s 2003 Natural Gas Market Assessment last week at the Commission’s regular meeting. In her presentation, OMOI Acting Director Lisa L. Carter revealed that there currently are 67 open investigations into potential market manipulation and the number of investigations has been increasing.

The OMOI outlined for the commissioners five current categories of natural gas price manipulation that are being investigated:

What plays a large role in creating the environment for manipulation to occur is related to another one of the OMOI’s concerns: the deteriorating financial condition of many energy companies and the rapidly approaching need to restructure debt over the next few years. In the report, OMOI notes that about one third of the long-term debt will mature for energy companies over the next five years. Short-term debt will put additional stress on the system. “It is likely that some companies will not be able to manage through these debt maturities and will fail,” OMOI said. “Many of these companies are active participants in the natural gas market.”

OMOI also noted that 15 companies already have announced plans to either withdraw from energy trading or reduce their trading and marketing operations, including Allegheny Energy, American Electric Power, Aquila, Calpine, CMS, Dynegy, El Paso, Enron, Idacorp, Mirant, PG&E, Reliant, TXU, UBS Warburg, and Williams.

“The reduction in the number of natural gas traders is particularly troublesome in the natural gas marketplace because there are so many regional markets, already somewhat illiquid due to fragmentation,” OMOI said in its assessment. “Dividing these markets by fewer traders can give remaining traders market power, permitting them to increase above competitive levels the difference between what they are willing to pay sellers and demand in payment from buyers. Some difference in prices paid and charged — the bid-ask spread — is necessary for traders to exist.

“In particularly thin markets, however, if a trading company increased the bid-ask spread beyond competitive levels it could be exercising inappropriate market power.”

The report also noted that the reduction in the number of agency agreements or asset management contracts between marketers and utilities can increase the risks placed on consumers.

The constrained financial conditions also contribute to another concern on OMOI’s list: the decrease in infrastructure investment. OMOI noted that “recent credit downgrades mean higher interest rates and costlier projects… Delays have increased. These delays and cancellations can affect the efficacy of pipeline expansion.”

OMOI noted that current extremely high gas prices illustrate the need for greater investment in production and pipeline capacity, particularly in the Rocky Mountain region, the New York metropolitan area, other parts of the Northeast and possibly the Southeast as well.

The industry is taking action with many companies cutting costs, renegotiating debt and selling assets. Meanwhile, industry groups, such as the Committee of Chief Risk Officers from 31 energy companies, are developing recommendations for best industry practices and working to standardized agreements and risk management methods. The Electric Power Supply Association intends to describe and codify ethical standards for the power supply and trading industry and require certification of these standards as a condition for membership.

Trading companies also have turned to greater use of electronic trading exchanges and clearing services to minimize risk and the need for collateral. OMOI provided an entire chapter in its report on new methods of managing credit exposure, including the use of clearing services through the New York Mercantile Exchange, Energy Clear and IntercontinentalExchange. In fact, FERC and the Commodity Futures Trading Commission plan to hold a special conference on this issue on Wednesday, Feb. 5.

New financial players with high credit ratings, such as Bank of America, Goldman Sachs, Morgan Stanley and others, also have entered the marketplace to fill the growing void left by exiting traders. But OMOI said this may be causing a transition to higher prices.

“The positive effects of this new participation do not yet represent successes that balance the recent failures of trading leaders,” the report said. “OMOI expects that the services provided by the new entrants will be more expensive than past offerings because they will likely incorporate more realistic credit risks into prices. Companies such as Enron and Dynegy were determined to create liquid markets in energy necessary for meeting their growth projections and profitability.”

The Commission’s reach in these matters is limited, but what it is doing to further the process of market recovery, OMOI said, is developing guidance on cash management practices between regulated subsidiaries and their parent companies, and establishing, on a case-by-case basis, creditworthiness standards that interstate pipelines may require in their tariffs. The only other thing that can be done by FERC and OMOI is to monitor the situation.

The OMOI also detailed the numerous reports by energy trading companies of reporting false information to energy trade publications with the purpose of manipulating the gas price indices the publications report. These disclosures have caused a “crisis of confidence” in the indices, according to OMOI, that could lead to contracts unraveling and hinder the writing of new contracts. However, OMOI noted that the industry and the trade press have been working on best practices for reporting prices. FERC staff has issued some recommendations and requirements regarding the use of price indices in regulatory proceedings on pipeline cashout provisions, penalties and negotiated rates. The Commission also intends to play a role in the matter by holding a technical conference this spring.

Meanwhile, the OMOI will keep a close watch on the market, where the potential for manipulation has increased due to the many other factors negatively affecting market functions, including decreased liquidity and tight pipeline capacity. The Commission has been holding regular internal energy market briefings.

In addition, OMOI said it is developing a set of gas and electric market metrics and thresholds designed so that when anomalies occur, OMOI investigates to determine if the deviations can be explained by physical market imbalances, by market rule problems or by improper market behavior. FERC also has increased coordination with other regulatory bodies. And OMOI operates the Commission’s toll-free enforcement hotline, (877-FERC-MOI), which received about 600 calls in 2002. Continued vigilance is necessary in light of the possibility of continuing manipulation.

The staff presentation is available on the FERC web site at https://www.ferc.gov/market-oversight/a-3.pdf.

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