Upwardly mobile

As energy prices creep upward, many factors are driving the markets. The upward trend and increased volatility is continuing as the markets evolve and mature. But are these markets operating efficiently and accurately, or are they being manipulated, as some accuse? By Eric Fishhaut

In the US, recent cold weather spells in some regions are having a direct impact on natural gas, heating oil and crude oil. This, combined with lower storage reserves than last year has applied intense upward pressure on prices. In the northeast, the spot price of natural gas spiked in January this year to a historical high of over $44 per mmBtu – more than 15% higher than previous highs in the year 2000 (see figure 1). Similar changes are evident in the European markets as well, with prices staying higher than the previous year (see figure 2).

Crude oil markets are following a similar pattern, stimulated by lower reserves and heavier demand (see figure 3). Recent prices seem to be maintaining consistently high levels in the upper range of the historical price bands while creeping towards highs seen only during the first Gulf War and briefly during the winter of 2002-2003. Clear evidence of price volatility can be seen in the average daily price movement for the New York Mercantile Exchange (Nymex) crude oil futures, which was 56 cents during 2003 compared with 42 cents in 2002. Likewise, the natural gas futures moved 16 cents daily on average, up from 9 cents in the previous year. Examining some evolving aspects of the markets should provide a deeper understanding of these movements.

Market centres

The US natural gas market operates through a structure of market centres and hubs that offer transport and interconnections between pipelines, as well as the physical coverage of receipt and delivery balancing. They provide services that improve the gas transportation process, such as web access to gas trading platforms and capacity release programs. But the primary functions of a natural gas market centre are to provide customers with receipt and delivery access to pipeline systems, provide transportation between these points and offer important administrative services that facilitate the movement and/or transfer of ownership.

There are currently 37 operational market centres in North America: 28 in the US and nine in Canada (down from 39 in 1996; five newly proposed hubs have also been cancelled). In the last few years, competition has grown with the demise of numerous gas marketing firms and the closing of many energy trading platforms.

More than half of the active US gas market centres are situated in the southwest - the largest gas producing area in North America. The most active centre, the Henry Hub, is located here and handles more than 180 customers through 14 interconnecting pipeline systems and a substantial storage facility. This hub also serves as the delivery point for the Nymex natural gas futures contracts (see figure 4). Key to the hub’s large daily volumes is the availability of transaction data and gas prices, which helps customers trade at prices that reflect supply and demand.

The prices for many services provided by the centres are driven by the local markets. But the key services – transportation and storage – are regulated by government. Typically, these rates are based on cost-of-service, set at levels that allow the recovery of expenses plus an allowed rate of return on the service assets. Only four of the US market centres currently offer market-based rates for these key services, charging below the cost-of-service rate and making up the difference by selling other, unregulated services.

Three quarters of the market centres provide their customers with internet access to trading/nomination platforms and web pages. Indeed, many centres even provide a platform for anonymous buying and selling opportunities. Much of the business can be completed online, although some details still require phone or fax communication to complete a deal.

Price discovery

As recent history has taught us, price transparency is key to the financial health of the markets. Full disclosure of price and quantity of transactions without revealing the parties must be captured, aggregated and made public. In the gas markets, the price information market is somewhat fragmented. Other than futures exchanges, real-time intra-day price information is only available through brokers or online systems such as Intercontinental Exchange for customers of those systems. Through these systems, current spot price information is available for active trading locations.

Price reporting services provide previous day prices for numerous trading locations, based on data from market traders and corporate trading firms, serving as the backbone for gas purchase contracts, market analysis and planning.

The discovery of erroneous reporting in this process has put the entire practice of price collection under close scrutiny. Consequently, the Federal Energy Regulatory Commission (Ferc) and the Securities Exchange Commission have developed voluntary guidelines for gas trade price reporting that are designed to eliminate suspect activities.

Efforts are being made to restore confidence in market price data. In fact, Ferc has started a survey of gas and electric participants to collect information on price data development intended to monitor the process of price discovery. Their policy statement specifies the desirable characteristics of a price index and the standards to be met by companies reporting their transactions. These standards form the basis of the “safe harbour” for participants, and those companies following the standards will not be penalised for inadvertent errors. This policy is intended to increase voluntary participation and accuracy in the price gathering process. The proposed US energy bill instructs Ferc to issue rules requiring timely reporting about the availability and prices of natural gas sold in the wholesale market to both Ferc and index publishers.

A further, independent initiative – Energy Data Hub – is currently under way (see Energy Risk January 2004, page 28). The hub will be a not-for-profit energy data provider based on transactions reported by the market aimed at improving the price discovery process. It will gather, store and distribute price data as an independent operation, focusing first on power and natural gas prices, but could soon include oil prices. Acting only as a central collection and repository vehicle, it will provide data to Ferc, index publishers and market forecasters, matching transaction information independently submitted by both buyers and sellers. It will report only those transactions that can be confirmed by both parties, eliminating inaccurate and duplicate reports that can skew the index calculations.

The impact of these efforts should be evident once they take shape and mature. Some argue that the markets have already benefited from increased examination. And some insist that big changes are not required and that the industry participants can clean up their collective act. In the meantime, we all need to get used to rapid and sometimes shocking price changes.

Eric Fishhaut is vice-president for technology strategy at GlobalView Software in Chicago. email: [e-mail]