Presented to:Annual Membership Meeting and National Energy

Restructuring ConferenceWashington, DCMarch 31, 2004

Monitoring Price Integrity: A CriticalMarket Component

William F. Hederman, DirectorOffice of Market Oversight and Investigations

Federal Energy Regulatory Commission

WFH-3/17/04

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Outline

• FERC’s Overall Strategy

• Market Overview

• Confidence building: price index/reporting initiative

• Conclusion

(Opinions: my own, not Commission’s)

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FERC has a 3-pronged strategy.

Effective Rules

Infrastructure

Rules

Enforcement

CompetitiveMarkets

Just & ReasonableOutcomes

StrategicApproach

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Natural Gas & Electric Market Space

Gas Supply

Trading Venues

Futures (NYMEX)

Electronic Platforms

Bilateral Trading

Voice Brokers

Pipelines&

Storage

Players

Delivered Market

Physical Nat Gas

Generation

Transmission&

Pumped Storage

Delivered Market

Phys Electric Power

Gas to fuel power generation

RTO’s & ISO’s

Price Contributors-Fixed price buyers & sellers-Speculators

Price Takers-Indexed price buyers & sellers

Source: FERC-OMTR&OMOI

Nat Gas & Electric Derivatives

Nat Gas & Electric Clearing

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Price Index Background

• Sharp reduction in energy trading in 2002• Instances of index manipulation led to FERC and CFTC

scrutiny• Many companies decided not to “risk” reporting• Fewer fixed price deals, more “at index”• Price index developers had less data to create indices• Indices still essential component of markets for pricing deals;

setting royalty payments; tracking prices; settling futures contracts; hedging gas transportation costs; pricing cash-outs or penalties in tariffs; and benchmarking prudent transactions

• Need to restore confidence in indices—they must be accurate, reliable, and transparent

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Essentials in the Policy Statement

• Focuses on near-term improvements to existing system of voluntary reporting

• Outlines standards expected of both index developers and price reporters

• Embraces “safe harbor” approach to encourage more reporting

• Prospectively requires indices in gas tariffs (i.e., for cash-outs) to meet standards and “reflect adequate liquidity”

• Directs Staff to monitor and report developments under Policy Statement

• Notes that failure of industry to respond could result in mandatory price reporting

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Standards for Price Index Developers

1. Code of conduct and confidentiality

2. Completeness—maximum information and liquidity measures

3. Data verification, error correction, and monitoring

4. Verifiability—process audit

5. Accessibility—for customers and FERC

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Standards for Reporting Prices

1. Code of conduct—on trading and reporting

2. Source of data—independent from traders

3. Data reported—each bilateral physical trade, with price, volume, buy/sell indicator, delivery/receipt location, date and time, term

4. Error resolution process

5. Data retention and review—3 year retention, independent audit

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Monitoring the Policy Statement

• OMOI is engaging in proactive monitoring, sending message to industry that FERC is impatient to see improvement

• Status report given to FERC at October 22 meeting

• Survey of industry on trading and reporting before and after issuance of Policy Statement conducted in October

• OMOI is meeting with trade associations to get input and encourage members to report trades

• OMOI is meeting with index developers to review adherence to standards

• Workshop on liquidity held at FERC in November

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Survey

• Sent to 266 companies—producers, generators, traders, LDCs, utilities, industrial users

• Covers trading and reporting practices before and after Policy Statement—ten questions:

Do you trade? What do you trade? Do you report? What portion of trades are reported? Are trades reported to one or to more than one index developer? Do you report through exchanges or to publications? What transaction details to you report? Who submits the report? Do you have an audit process? Do you have a code of conduct for trading and/or reporting?

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Liquidity Issues

• Index used in gas tariff must meet standards and “reflect adequate liquidity” at the relevant location

• Economic literature on liquidity not helpful

• OMOI must report to FERC on index publishers and liquidity January 2003

• Workshop on how to measure adequate liquidity held at FERC in November

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Market Integrity is Everyone’s Business

FERC Hotline:

1-888-889-8030