A detailed investigative report published last month by industry newsletter Inside FERC’s Gas Market Report suggests that a Texas intrastate gas pipeline company may have systematically attempted to manipulate spreads between physical and financial gas contracts trading at the Houston Ship Channel pricing point. The intrastate gas transportation market in Texas is lightly regulated, relative to federally regulated interstate pipelines, and there is not requirement at the state level for a clear separation between a company’s gas merchant and gas transportation business. The article intimates that light-handed regulation may have allowed price manipulation. However, from my reading of the article, there is no clear evidence of manipulation, and therefore little reason to think that there is some sort of “regulatory gap” that needs to be filled.
Houston Ship Channel, one of the most vibrant spot gas markets in Texas and a benchmark for prices across the state, has confounded traders, end-users and market analysts over the past 18 months because of unexpectedly low prices and a sudden divergence of physical and financial markets.
The report cites “two traders active in the Ship Channel market, who spoke on the condition of anonymity because they are not authorized by their companies to discuss gas markets with journalists” as linking the market changes to a single company’s “aggressive pursuit of a commonly used trading strategy.”
At Ship Channel, from late 2004 through early 2006, the two traders said a seller in the monthly market would swoop in on the IntercontinentalExchange trading platform on the third day of the five-day physical bidweek trading period – the day the NYMEX contract expires – and offer physical gas for the following month at prices well below earlier deals that day and the previous two days….
“Everybody in the industry knows it was [Energy Transfer Co.],” said one of the traders. “I have that knowledge from watching the market and from conversations. Everybody talked about ETC and the Ship Channel index. It’s common knowledge.”
According to the article, the goal was to drive down the price for physical gas and profit on the increased spread between prices for physical and financial gas products. As the chart shows, reproduced from the article, there were a couple of big blips in the spread between physical and financial prices, particularly for October and December 2004, and September, October, and November 2005 contracts. At other times there was a fairly modest spread between the two prices.
The problem for the story is that it hangs primarily on the few dramatic spikes in the spreads, and those spikes already have fairly reasonable explanations. Starting with the big spreads: hurricane Katrina hit the Gulf Coast in late August 2005 (during the time that trading on the September 2005 futures contracts were being settled) and Rita hit in late September 2005. Both hurricanes caused significant disruptions to normal gas production and transportation, and not surprisingly significant effects on the market. [PDF] September 2005 saw three major hurricanes in Florida and along the Gulf Coast – Frances, Ivan, and Jeanne. The December 2004 price on the financial gas products side (NYMEX gas futures price) was driven up by an erroneous gas storage report distributed by the Energy Information Administration that suggested inventories were lower than expected going into the heating season.
Take out the effects of these surprises on the market and you are left with the August and September 2006 spreads as being modestly larger than “normal” for the market. The two recent months come at a time when prices were dropping faster than many expected (Amaranth?) and after ETC stopped engaging in the trading practice according to the article, which leaves us with nothing, really, to worry about.
If the ETC trading practices were common knowledge, there is little reason to expect much of an effect on the market. People on the other side of the transaction will line up to take advantage of a party willing to dump contracts on the market at “below market” prices. In fact, that was exactly what happened in this case, according to the article. The market was largely self regulating, and so there is little reason to think additional outside regulation would help anyone on either side of the any of these markets.
ADDED LATER: Despite, or maybe because of, my generally negative conclusions concerning the published results of the this investigation, I should say that I was impressed by the efforts of the reporter to put together the story and by the willingness of the publisher to print it. Often industry newsletters seem to shy away from printing something like this that may upset a subscriber. You can only get to part of the report unless you register with the Platt’s website (or subscribe), but if you see the full story it is clear that a lot of work went into the investigation. While there appears to be little support for the allegation of market manipulation, overall I’m glad that the reporter and publisher did the story.