European energy dealers often trade at a loss to help profits

Tue Nov 6, 2012 3:28pm GMT

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* EU power, gas, coal all see forms off loss-leading trading

* EU plans to impose clearer rules

* New regulation slow in being implemented

By Henning Gloystein and Oleg Vukmanovic

LONDON, Nov 6 (Reuters) - Dealers on Europe's energy market commonly trade coal, gas or power at a loss to push up profits on futures prices, industry sources say, a practice that regulators want to stop.

Uneconomic or loss-leading trades are explicitly banned in the United States where British bank Barclays has been accused of using them to rig California's electricity prices.

In Europe, the law is not so clear. Regulators have introduced new rules aimed at preventing market manipulation but lawyers say there is room for interpretation and nobody has yet been investigated. Officials want to strengthen the rules.

"Loss-leading trading happens across all energy markets I know of, and while it's not as frequent as it used to be when regulation was really lax, it's still a fairly frequent practice, especially in less liquid trading," a trader with experience at major banks and utilities said.

Dealers take a loss by paying over the odds for spot power, coal or gas when market information suggests the price should be lower. The rise in spot prices lifts forward contracts, in which the trader takes a larger position, increasing profits.

The practice is particularly lucrative when trading is light and it is easier to move prices.

A source at a trading analytics firm used by UK gas and electricity traders said there may have been manipulative practices in the UK gas market across several weeks in August, a time of low gas trading volumes.

He identified occasions when a trader put extreme bids into the market early in the morning to influence sentiment.

"I reckon someone's trying to manipulate it, which is easy enough in light volume markets," said the analyst who asked not to be identified.

MURKY REGULATION

EU officials want to make sure the practice is banned.

"The allegations that Barclays has manipulated U.S. energy markets further highlight concerns of manipulation of essential commodity prices," said Arlene McCarthy, a British Labour member of the European Parliament.

"We need to have more research and information on whether there is a trend or pattern of manipulation of commodities and price indices in order to establish rules to prevent distortion and ensure the integrity of markets."

Laws introduced last year aimed at preventing the use of insider information and other forms of market manipulation did not go far enough and they are now proposing to toughen them up.

Unlike in the United States, the existing rules do not specify that such trading is illegal and this means they are open to interpretation.

"Although the practice (of loss-leading trading) is not specifically mentioned, it could be seen as equivalent to specified market manipulative cases of 'pump and dump or 'market cornering'," Matthias Lang, a partner with law company Bird & Bird said.

The EU says its proposals will tighten the broader rules.

"Under EU rules, manipulation of EU power markets is expressly forbidden," Stefaan de Rynck, a European Commission spokesman said.

"The Commission has presented proposals to strengthen the existing Market Abuse Directive (MAD). Under the proposed regulation, cross-market manipulation between spot and financial markets would be explicitly forbidden (and) the proposals are under negotiation in the European Parliament and the Council."

HARD TO PIN DOWN

Even when the new proposals are adopted traders say that loss-leading would be hard to pin down.

"If you want to prove this, you have to know all a company's bids on the exchange and brokered market and know exactly all asset operations," said the former bank and utility trader.

"This will be very hard, especially as most spot trades are exchange-based while most forward trading is OTC-brokered."

Brokers in off-exchange markets, known as over-the-counter (OTC) deals, do not publish their customer trade details.

Additionally, the EU watchdog Acer cannot act on its own behalf under the REMIT rules but can only urge national regulators to interfere and put penalties in place.

Asked whether it monitors loss-leading trading, British regulator Ofgem said "we monitor the market at all times using our existing powers. In preparing for full implementation of this legislation, we will consider evidence of market abuse that is brought to our attention."

At present, Ofgem is not investigating loss-leading trading at any of Britain's utilities, information on its website shows. Some utilities say they are not engaging in loss-leading trading tactics f or fear of being investigated by the regulators, especially if the rules are tightened.

German utility E.ON - which operates in all major European power, gas and coal markets - said that it already views loss-leading trading as illegal, and that it would soon trigger regulatory intervention.

"In our view such trading behaviour is already against EU-regulations of REMIT and MAD, and regulatory procedures in Europe already cover such related trading operations or will do so in the near future," E.ON spokesman Georg Oppermann said.

E.ON's closest German rival, RWE, which also operates in all major energy markets, said its traders do not use loss-leading trading tactics.

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