Wholesale gas pricing system open to abuse, traders say

LONDON Tue Nov 13, 2012 3:18pm GMT

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LONDON (Reuters) - The reporting method used by industry media in the UK gas market to assess daily prices, at the centre of a regulatory probe, is flawed and easy to manipulate, some traders in the sector say.

The Financial Services Authority (FSA) and energy regulator Ofgem are investigating allegations made by a whistleblower that traders have manipulated wholesale prices on Europe's biggest gas market, a trend-setter across the continent.

Although the example highlighted in the probe relates to the benchmark price on a certain day being lowered and not raised, the issue is a political tinderbox in Britain, where five of the six dominant energy distributors increased retail energy bills for this winter.

"I don't think it's possible to exaggerate how serious this would be if the allegations turn out to be true at a time when so many people are struggling to pay their bills, are making huge efforts just to make ends meet," Deputy Prime Minister Nick Clegg said on Sky News.

The allegations have also been compared to an uproar this year over rigging of the Libor interbank interest rate, raising questions about the reliability of market mechanisms that directly affect everyday transactions by the public.

Whistleblower Seth Freedman, who works for price reporting agency ICIS Heren and spoke to the Guardian newspaper, sought to show how traders submitted erroneous bids and offers at the end of the day to skew the day-ahead gas contract, which is used to guide a wide-range of physical and futures gas prices.

"Traders always try to jerk the day-ahead close," the company's founder, Patrick Heren, now retired, said on Twitter.

"The effects are minuscule compared to the way the government is trying to rig the market," Heren added, apparently referring to energy market reforms, meant to encourage renewable sources, that add to prices.

ICIS Heren itself reported "unusual trading activity" to regulators back in October, several weeks before Freedman approached the FSA, regarding UK gas trades done on September 28 - the end of the gas financial year, a sensitive period for gas prices.

"The cause of the trading pattern, which involved a series of deals done below the prevailing market trend, has not yet been established," it said in a statement.

ICIS Heren is the leading price reporting agency that aims to provide energy company clients with a transparent, daily price of wholesale gas used in contracts for billions of pounds worth of supply deals. Energy information services Platts and Argus also provide prices in the gas markets but their prices are more commonly used in cash oil market contracts.

ICIS Heren price reporters go about setting the wholesale cost of gas by telephoning traders and collecting data during the peak trading window for gas at around 4.30 p.m. London time, known as the market-on-close assessment.

High trading volumes in this period are deemed to provide the best snapshot of gas prices as multiple sellers and buyers strike deals.

Some traders criticised the approach for focusing on a narrow assessment window that they say invites manipulation by players that want a higher or lower price to suit deals related to the benchmark price.

WILD WEST

"It's a complete Wild West in the market for that period, especially the few seconds before (the assessment period expires)," one UK gas trader said.

"It's Heren's fault for setting the price like it does on literally the closest trade to 4.30 (p.m) it can find," he said.

"If someone is buying a liquefied natural gas cargo based on that index then you can move the index down day-by-day to lower the price you pay for the LNG," he said.

An ICIS Heren spokesman confirmed that reporters set the price of gas at 4.30 p.m. London time using the best bid and offer, although they can disregard outlying or otherwise suspicious bids.

ICIS Heren has welcomed the Ofgem probe into wholesale gas trading activity based on its own submissions to the regulator.

Some other traders questioned the very need for an assessment process to determine day-ahead and other gas contract prices on liquid markets like that in Britain, which is known as the National Balancing Point (NBP).

"Why have a window at all on the day-ahead?" another trader said.

"Why not just day-ahead averages? What is the advantage of a window with a market as liquid as the NBP?" he said.

Proponents of averaged gas prices argue that extreme trades and bids would be ironed out in the final assessment, making it less prone to manipulation.

Britain's Department of Energy and Climate Change said on Monday that regulators were well equipped to deal with any problem in the gas market.

"The government has a strong record in providing the regulators with powers to regulate conduct in our markets. Where gaps in powers have been identified, action has been taken," it said.

Utilities Centrica, E.ON and SSE all distanced themselves from allegations of manipulation, pointing to robust governance and compliance policies.

Centrica said its own traders were prohibited from providing price information to price reporting agencies, and emphasised that there were more than 50 participants in the market, not just energy suppliers.

E.ON said it had "most stringent training and compliance regimes in the industry" and that it viewed any attempt to manipulate benchmarks as illegal.

SSE said: "We are entirely confident that our Energy Portfolio Management team operate in a fair and legitimate way."

Platts said it was drafting a statement in relation to the gas price manipulation allegations, while Argus could not be immediately reached for comment.

(Additional reporting by Peter Griffiths; editing by Anthony Barker and Richard Mably)

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