[Federal Register Volume 68, Number 118 (Thursday, June 19, 2003)]
[Notices]
[Pages 36783-36786]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-15558]


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DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

[Docket No. AD03-7-001]


Natural Gas Price Formation; Staff Paper on Price Formation 
Issues

June 13, 2003.
    On May 29, 2003, the Commission issued a ``Notice of Staff 
Technical Conference & Workshop on Energy Price Discovery & Indices' on 
issues surrounding price formation and price indices for natural gas 
and electricity. The conference and workshop will be held, in 
conjunction with the staff and commissioners from the Commodity Futures 
Trading Commission and the National Association of Regulatory Utility 
Commissioners, at FERC headquarters on June 24, 2003.

Introduction and Problem Definition

    A crisis of confidence over the reliability of energy price indices 
and the uncertainty over industry expectations and government 
regulatory guidelines now inhibits the progress of energy markets. 
Reports of past attempts at index manipulation and unreliable or non-
transparent statistical methods undercut markets that depend on 
indices.\1\ Recently, there have also been concerns about a lack of 
information about price liquidity, such that market participants base 
decisions on misperceptions about how many actual transactions were 
used to set the price. Since index dependencies permeate the energy 
industry, accurate price discovery must exist for markets to function 
properly and efficiently.
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    \1\ In 2002 the Western Markets Task Force investigated the role 
natural gas indices played in the prices charged for electricity in 
California. The Final Report on Price Manipulation in Western 
Markets, issued March 2003 in Docket No. PA02-2-000, determined that 
employees of several companies had reported false information to 
publishers of price indices in an effort to skew indices in favor of 
their trading activities positions (short or long) taken in both the 
physical and financial markets. In addition, the investigation found 
that other companies had no system in place to ensure the accuracy 
of the data being reported to the index publishers.
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    There are also concerns about changes in the amount of trading, 
both generally and with certain types of contracts. Gas commodity 
markets have shifted from primary reliance on a prompt month (bid week) 
spot market and longer term forward markets to include active next day 
and balance-of-month markets. Next-day trading appears to be robust, 
with a majority of next-day trades being executed on electronic 
exchange platforms. Transactions in the month-ahead market, however, 
have declined significantly in the wake of a collapse in the marketing 
segment of the gas industry. Monthly indices, however, apparently 
remain important reference points for indexed contracts, settlements 
for swaps, settlements for pipeline imbalances, etc. We are interested 
in exploring the vitality of trading in the month-ahead market and the 
role it plays in price formation under current conditions.
    Another concern is the degree of reliance on index-based contracts 
as opposed to fixed-price contracts. It appears that natural gas 
producers often sell ``at index'' and that many local distribution 
company purchasers buy at index-linked prices in lieu of negotiating 
fixed prices. Some have alleged that there is over-reliance on index 
pricing and that it is due to perceptions of what state commissions 
will consider to be prudent components of a procurement portfolio. 
Without enough fixed price transactions, there is a real concern that 
prices will not reflect market conditions.\2\ This is another aspect of 
liquidity concerns' improvements in price reporting, data quality, 
index methodologies, reporting procedures, and the like still will not 
produce the desired result if there are not enough fixed price trades 
to form prices.
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    \2\ Natural Gas Intelligence (NGI) recently issued an open 
letter to the Commission and a ``Statement on Natural Gas Price 
Surveys'' in which it noted the collapse in fixed price trading and 
the increased use of indices during volatile periods. NGI urged 
``buyers and sellers to do less indexing `` and more fixed price 
trading, particularly in the monthly baseload market.'' See 
www.intelligencepress.com/features/ngi_statement.html.
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    On April 24, 2003, Commission staff, with staff from the CFTC, held 
a technical conference to explore how improvements in price indices 
could promote confidence in natural gas markets. The conference 
provided us and participants with useful insights on price indices and 
their role in price formation, and staff appreciates the contributions 
of the conference

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participants. Many issues raised at the April 24 conference affect 
energy markets generally. Recognizing this, the Commission has expanded 
the scope of the upcoming conference to consider the role of price 
indices in the formation of prices for electricity as well as natural 
gas.
    The June 24 conference and workshop will consider both near-term 
improvements and long-term solutions to the current price formation 
process. To assist the industry in reaching consensus where possible, 
FERC staff outlines below possible criteria for price indices and 
questions which must be resolved in order to achieve a consensus 
solution and resolve the uncertainty. The criteria address both 
implementation issues and characteristics of good price reporting 
systems. We encourage parties to comment on these criteria and 
questions in written comments prior to the June 24 conference, and we 
encourage conference participants to address these issues in their 
remarks at the conference.

Implementation Criteria

    1. Near-term and long-term effectiveness. Near-term improvements 
are needed to bolster confidence in current price indices. Staff 
encourages consensus among market participants on steps needed 
immediately to improve price reporting, the process of calculating and 
publishing indices, and the information needed for the market to gauge 
liquidity.
    2. Cost considerations. The current system provides the service to 
the industry at moderate cost as part of the index providers' 
businesses. Any changes to the current system or any new approach to 
price formation that significantly upgrade the process for receiving 
and processing trade data will carry with it a need to fund the 
improvements or the new structure. Parties should address the problem 
of increased costs and the mechanism for funding changes in the current 
system.
    3. Applicability to electricity as well as gas. Price discovery is 
as important for the electric industry as it is for the natural gas 
industry. Spot and longer-term forward markets exist for electricity. 
The spot market for electricity has taken two forms. One is the day-
ahead and real-time markets administered by FERC-sanctioned RTOs and 
ISOs. The other is bilateral markets consisting of private transactions 
between market participants.\3\ Published indices report these 
transactions, in which many of the same problems and concerns have been 
raised. We request comment on the extent to which the solutions 
previously discussed in the context of gas indices apply equally for 
reporting of electricity indices.
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    \3\ The RTO/ISO markets are reliable and transparent. Many 
bilateral transactions are settled against prices set by the RTO/ISO 
markets. The newly reactivated NYMEX-PJM West futures contract also 
uses the daily real time PJM prices for settlement at the end of the 
contract month. Outside of the organized ISO/RTO markets, the 
bilateral markets rely on published indices (such as Megawatt 
Daily's Mass Hub, PJM West, NY Zone-G, Into Cinergy, Into Entergy, 
etc.) for settlements.
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    4. Implementation. The Commission has jurisdiction over natural gas 
sale-for-resale transactions that are not ``first sales,'' 
transportation by natural gas pipelines, and wholesale power 
transactions by public utilities. Also, sales for resale of Canadian 
gas are exempt from our jurisdiction. We request comment on the steps 
the Commission could take within its existing authorities, or with 
reasonably achievable legislative changes, to implement changes. For 
example, should the Commission condition the grant of market-based rate 
authority or the use of interstate transportation facilities (gas and 
electric) on the users' agreements to provide accurate and complete 
price reporting? Would such requirements be sufficient to assure that 
indices are representative of the market? Would such requirements 
guarantee a sufficient number of reported trades to resolve the concern 
over determining the actual liquidity at various trading hubs and/or 
the concern that price indices accurately reflect actual market 
activity? Are there steps the Commission could take to encourage all 
segments of the market to participate in active negotiation of prices 
in daily and monthly markets to ensure a statistically significant base 
of price information upon which to calculate indices?
    5. Providing regulatory certainty. Some market participants have 
suspended reporting trade data, partly out of concern over the present 
uncertainty in price index development. Such participants may be 
concerned that their reporting practices or errors in information 
reported could lead to accusations of providing inaccurate or 
incomplete data. One means of addressing this perceived risk would be 
adopting standard practices for reporting trade data. We recognize the 
need to provide as much regulatory certainty as possible for good faith 
reporting of trade data, while still enabling the Commission to take 
action against false reporting or attempted manipulation of price 
indices. We encourage industry consensus on reporting standards to 
facilitate regulatory certainty.

Price Index Criteria

    Comments at the April 24 conference show that the industry is 
working on criteria for various aspects of reporting and processing 
trade data and producing better price indices. One group, the Committee 
of Chief Risk Officers, issued a White Paper proposing ``Best Practices 
for Energy Price Indices.'' Those practices address desirable 
attributes for several aspects of determining price indices.\4\ We 
request comment on the following criteria for developing price indices.
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    \4\ The recommended best practices include reporting full 
transaction-by-transaction data; publication by the index developer 
of the methodologies used, including definitions of sample size, 
treatment of double-counting and outliers, and method for 
determining a value when there is insufficient data; an error 
resolution process; strong confidentiality agreements; and periodic 
process audits for data suppliers and index developers. See 
www.ccro.org/bestprac.html.
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    1. Confidential. An index developer should provide confidentiality 
agreements to assure entities that commercially sensitive individual 
transaction data submitted will be held in confidence except to the 
extent necessary to verify the index and allow for any regulatory 
oversight
    2. Complete. Price reporting systems should maximize the amount of 
useful and appropriate information they collect and disseminate. 
Complete information would include actual transaction variables such as 
price, volume, delivery point, duration, date and time, whether the 
transaction is a purchase or sale, and the counterparties to the 
transaction. Useful information to disseminate includes price, volume, 
location, type of contract, time, and liquidity. In particular, there 
should be some measure that informs customers how many actual 
transactions led to an index price.\5\
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    \5\ We encourage the development of liquidity measures that 
classify trading points by liquidity and provide specific 
information about the number of trades or indicate graduated levels 
of activity.
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    3. Transparent. Customers of price reports should be able to know 
how the information was developed. They should know about index 
calculation methodologies including relevant formulas and algorithms, 
treatment of aberrant data, and use of judgments, assessments, or 
similar subjective adjustments.
    4. Verifiable. Customers of indices should have faith that the 
information they rely upon has been verified by a sufficiently thorough 
and independent audit process. Quality control measures, including a 
verification and error

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resolution process that includes buy-sell matching, should apply to the 
data. An index developer should: Provide adequate security for 
collected data, including a backup system; have the ability to process 
large quantities of data quickly and accurately; and possess sufficient 
market knowledge and statistical expertise to recognize errors in 
reported data.
    5. Accessible. All interested customers should have reasonable 
access to price reports on a timely basis.

Questions

    We seek responses to key questions in order to achieve an 
appropriate solution:
    1. Should the Commission have access to the data? Under the current 
regime of trade publication indices, the Commission and the CFTC have 
limited ability to investigate allegations of manipulation. Can this 
regime achieve the goals of verifiability and transparency? Are there 
near-or long-term changes that could be made to achieve sufficient 
verifiability and transparency other than allowing for regulatory 
review?
    2. Should the Commission mandate reporting? The volume of 
transactions reported has declined, as companies have suspended 
reporting due to uncertainty over reporting standards or to review 
their procedures and safeguards for reporting accurate information.\6\ 
Developers of price indices have expressed concern that withholding 
trade information from the market undermines the index process.\7\ The 
reluctance of some companies to report trade information voluntarily 
raises the question of whether trade reporting should be mandatory. Due 
to antitrust laws, the industry acting alone could not implement 
certain means of requiring report, such as stopping trading with non-
reporting companies. In other markets where ``self-regulating 
organizations'' (SROs) exist there have been exemptions to such 
antitrust laws allowing mandatory reporting. Should the Commission 
require entities holding blanket market-based rate authority to report 
specified trade information to one or more index developers whose 
indices meet specified standards, subject to adequate confidentiality 
protections? How can sufficient completeness be achieved without some 
form of mandate to report? How could the Commission implement a mandate 
under current law? Would legislation allowing the Commission to mandate 
price reporting help?
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    \6\ Recently, for example, Entergy-Koch Trading announced that 
it has suspended all price reporting ``until there is further 
clarity and certainty around industry expectations and the 
government regulation guidelines.''
    \7\ For example, in NGI's ``Statement on Natural Gas Price 
Surveys,'' NGI urged ``companies which have not reported prices in 
the past or who have let their price reporting lapse to make 
contributions to our surveys in the interests of a robust market 
measure.'' See www.intelligencepress.com/features/ngi_statement.html.
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    3. Should reports include counterparties? The verification process 
effectiveness increases when the index provider has information on 
whether a transaction was a purchase or sale, with counterparty company 
name. Some reporting companies have commented that this information is 
highly sensitive and that they will not report the data to a third 
party, or that non-disclosure agreements bar reporting such 
information. Others, including index providers, argue that without 
counterparty data they cannot confirm reported trades and thus assure 
accuracy in the data used to construct indices. Staff recognizes the 
fundamental tension between the need to ensure accurate indices and to 
protect commercially sensitive information. Is there a way to achieve 
sufficient verifiability without a buy/sell indicator and counterparty 
information? If there were a requirement to report counterparty data, 
what protections could the Commission or an index developer provide for 
commercially sensitive information?
    4. Should there be an external audit? There appears to be general 
consensus that some audit process is necessary to achieve verifiability 
but less agreement on the nature of the audit process. The highest 
degree of confidence would result from an external process and data 
audit by a major independent firm, with the results of the audit (and 
underlying data) provided to the Commission for review. Some index 
providers argue that review of the information by anyone outside their 
company would raise liability and impose costs. However, an audit 
process that only addresses process or that is only internal would 
provide less transparency and confidence. Staff views auditing and 
reporting to the Commission as central to restoring confidence in price 
indices. Parties should comment on the type of audits and reports best 
suited to achieving verifiability.
    5. Should the Commission authorize price reporting entities? How 
can the Commission implement standards of review, reporting, 
confidentiality and auditing? Are there minimum standards that the 
Commission could apply to price reporting entities? How can companies 
providing transaction data have assurance that they are providing data 
to bona fide price reporting entities?
    6. Should the Commission delegate any regulatory functions to an 
SRO? If so, which one? Depending on the scope of regulatory functions 
deemed appropriate to oversee price discovery mechanisms, the 
Commission could delegate many such functions to an SRO. These include 
standards of conduct, compliance, surveillance, auditing, enforcement, 
rulemaking, standardization of formats, dispute resolution, 
adjudication, and membership requirements.
    SROs are well-established in certain financial industries, often 
operating under supervision from agencies that have been granted 
specific legislative authority.\8\ We request comment on the steps that 
would be necessary for the Commission to sponsor or validate an SRO-
type entity for price formation in the energy industry. SROs also raise 
significant questions of cost, governance and oversight. If the 
Commission mandated use of an SRO and/or subjected the SRO to 
government oversight, would the Commission need additional specific 
legislative authority to create and regulate such an SRO? If the 
Commission were given authority or direction to supervise price 
formation mechanisms, could it delegate some price surveillance to an 
SRO? We request comment on the extent of the Commission's current 
powers to accomplish an SRO solution.\9\
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    \8\ For instance, the National Futures Association registers and 
monitoring futures brokers under the oversight of the CFTC and 
pursuant to legislative provisions; GovPX, Inc. is a private company 
which benchmarks U.S. Treasury market prices without legislative 
provisions, but with the approval of the U.S. Treasury and Federal 
Reserve.
    \9\ Two examples include the InterContinental Exchange (ICE) 
which suggests that its existing eConfirm system currently operates 
as a central processing platform hub, and the University of Houston 
Global Energy Management Institute (UH-GEM) which proposes to 
develop a new energy price data hub within six months.
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    Advantages of an SRO are centralizing the process of reporting, 
processing, and disseminating data under conditions which provide for 
oversight and auditing, creating a high degree of confidence. 
Disadvantages include the time to select or create the SRO, potential 
need for legislative authority, and potential disruption in the 
transition from existing indices to new indices resulting from SRO data 
or published by the SRO, and the potential for significant costs.

Written Comments

    We encourage interested parties to submit written comments on the 
issues discussed above in advance of the June

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24 conference and workshop. We request that comments be filed by June 
20, 2003. Instructions on filing electronically can be found at http://www.ferc.gov/documents/makeanelectronicfiling/doorbell.htm.

Magalie R. Salas,
Secretary.
[FR Doc. 03-15558 Filed 6-18-03; 8:45 am]
BILLING CODE 6717-01-P