Energy analyst Roderick Bruce reports on allegations of gas market manipulation in the UK.
Regulators in the United Kingdom are investigating claims by a whistleblower at a price-reporting agency that indices forming the UK's wholesale day-ahead gas price may have been manipulated by traders.
The claims, submitted to energy regulator Ofgem and the Financial Services Authority (FSA) in October by an employee at ICIS Heren, centre on irregular over-the-counter (OTC) bidding during the half-hour pricing window on 28th September, a key settlement date marking the end of the UK gas year. However, such activity is also alleged by the whistleblower to be more widespread.
The UK’s National Balancing Point (NBP) gas hub price forms a key price-setting mechanism both domestically and for continental Europe. Should manipulation be proven, the desire by national and supra-national regulators to impose tougher trading rules on OTC energy markets will intensify.[Page Break]
Manipulation of key indices and markets – including the Libor bank lending rate – is turning up the political and regulatory heat on traders and the wider financial sector. However, the most scrutiny is likely to fall on price reporting agencies, whose unregulated role in energy price-setting is again being questioned.
The allegations of price manipulation in the United Kingdom's day-ahead gas market were made by Seth Freedman – who works at London-headquartered price-reporting agency (PRA) ICIS Heren – and published in The Guardian newspaper. Freedman had previously worked as a city trader and freelancer for The Guardian, before taking a job at ICIS Heren as a price reporter covering the UK gas market. [Page Break]
Freedman alleges that traders at a particular company deliberately submitted low bids during a half-hour pricing window on 28th September in order to depress the UK's day-ahead closing gas price. ICIS Heren acknowledges that 'unusual trading' took place, with trades submitted that were 'below the prevailing market trend'. ICIS Heren said it reported the irregular trading to energy regulator Ofgem in October.
According to The Guardian, Freedman's claims go further. He alleges that 'manipulation of gas prices is taking place on a regular basis', and that the United Kingdom's 'Big Six' utilities are among those involved in market abuse. The companies themselves have released statement denying the claims. Freedman also alleges that staff at PRAs are poorly trained, frequently pressured by traders, and have "over-cosy relationships" with them, resulting in key gas market indices being "unreliable", according to The Guardian.[Page Break]
Regulatory response
The allegations of market abuse in wholesale gas markets come amid heightened public and political scrutiny of the United Kingdom's power and gas sector. Pre-winter price hikes by the Big Six utilities were met with public anger, and were attributed by companies to rising wholesale market costs. With the integrity of those wholesale price benchmarks now being called into question, regulators will find themselves under even more pressure to attempt to enforce transparent, competitive wholesale markets. The UK Treasury was notified of the allegations on th November. UK energy secretary Ed Davey said that consumers 'deserve markets that are fair', while both Ofgem and the Financial Services Authority (FSA) have pledged to closely analyse the claims.
However, in these allegations consumer anger and regulatory scrutiny of the energy industry combines with a post-credit crunch suspicion of financial markets and institutions, along with an over-riding concern than 'light-touch' regulation of key benchmarks continues despite various high-level investigations. Davey himself was quick to draw a parallel between the alleged manipulation of gas prices and the regulatory response to the banks' manipulation of the Libor inter-bank lending rate. "We acted swiftly to tackle the attempted manipulation of Libor and Euribor and we are in the process of giving Ofgem more powers to tackle abuses," Davey said. [Page Break]
Libor's use in pricing other financial instruments, from bonds to pensions and mortgages, led to accusations that an index fundamental to the industry was inaccurate. The same concerns could now be raised about UK gas pricing, which is becoming an increasingly important component of longer term supply contracts, and strongly influences continental European gas hub prices.
An unrelated high-profile investigation has added to concerns about market transparency. Barclays Capital, one of the main protagonists in the Libor scandal, is under investigation by the US Commodities Futures Trading Commission (CFTC) for making "loss-leading" trades in the US power market. EU regulators are closely watching the US case to inform its own decisions regarding market abuse, as a raft of transparency regulation, including the Regulation on Wholesale Energy Markets Integrity and Transparency (REMIT) is implemented by member states. [Page Break]
The price is wrong?
Beyond the usual energy industry bogeymen focused on by the media, the allegations of price manipulation in the UK gas market re-ignite the debate about the role of PRAs in setting key energy industry benchmarks, including the Brent crude price.
Subsequent to the credit crunch, parallels were drawn between the opaque methodologies of the credit ratings agencies, such as Standard & Poor's, and those employed by the unregulated energy PRAs, the largest of which are Platts and Argus Media. The Libor scandal also increased calls for further regulation of key financial and price benchmarks, including those produced by PRAs.
A report by the International Organization of Securities Commissions (IOSCO) published in October found that no special direct regulation of PRAs was necessary, with Argus Media, Platts, and ICIS, including its Heren energy unit, pledging to self-regulate through the Price Reporting Code for Independent Price Reporting Organisations (IPRO Code). PRAs including ICIS Heren and Argus have appointed heads of compliance to ensure best practice, including close monitoring of the relationships between price reporters and traders to mitigate any undue influence. [Page Break]
PRAs point out that their methodologies, which include various price-setting mechanisms such as volume-weighted averages and Market-on-Close windows, are fully transparent and accepted by the wider industry. However, a submission to the IOSCO study by Total’s trading unit suggested that PRAs did not always accurately represent market activities, and "consequently deform the real price levels paid at every level of the price chain, including by the consumer."
Aside from broker screens and less-detailed volume and trade information collected by organisations such as the London Energy Brokers Association (LEBA), PRAs are still the only window on the opaque bilateral over-the-counter (OTC) energy markets. The alternative to relying on PRAs would be to force all OTC trades onto exchanges – a measure that was considered by US and EU regulators after the credit crunch. But that drastic measure, and the less onerous but still costly option of forcing all OTC trades to be cleared, would hit smaller end-users using the market to hedge their physical commodity risk. The costs of complying with all the European Union's transparency directives are already rocketing, and are in danger of pushing smaller counterparties out of the market, therefore reducing competition and liquidity.[Page Break]
Outlook and implications
A lack of transparency in OTC commodity markets has long been the bugbear of international regulators, and the allegations about manipulation of the UK gas market are likely to redouble calls for tougher government regulation of price reporting agencies, along with calls for tougher sanctions for traders who attempt to distort prices. The allegations are also likely to spark fresh criticism of the lack of competition among the Big Six utilities in the United Kingdom, with the structure of the power market also facing criticism. Companies involved in the wider OTC commodity markets are likely to staunchly defend their business practices, and their right to protect their competitive advantages by retaining a high degree of confidentiality. While there can be no question that market manipulation must be discouraged as strongly as possible – both by monitoring traders and parties involved in disseminating market data – a balance must be struck between transparency and over-regulation. A more strictly regulated OTC market is highly unlikely to result in lower energy prices for end consumers.
Roderick Bruce is an energy analyst with IHS. www.ihs.com
