Report highlights decline in US gas price reporting

The volume of US natural gas transactions being reported to index publishers such as New York-based Platts has fallen in recent years, even as the volume of trades that rely on those indexes for pricing has increased, said a July 14 report based on company filings with the US Federal Energy Regulatory Commission (Ferc).

The report by Cornerstone Research, a San Francisco-based consulting and analysis firm, underscores concerns that physical gas indexes, which are used to price a variety of physical contracts, futures and over-the-counter derivatives, may not be representative of the underlying market they track.

"What's troubling is if companies blindly price off an index as if on auto-pilot, without considering the data or fundamentals that underlie the index," says Jennifer Fordham, senior vice president for government affairs at the Washington, DC-based Natural Gas Supply Association (NGSA).

In its report, Cornerstone said that the volume of trades being reported to index publishers fell 15% in 2014 compared with the year before. Meanwhile, the volume of physical trades priced using the indexes grew by 3% over the same period. The disparity between the two has widened in recent years as companies have shifted towards conducting more trades priced using the indexes. In 2014, the volume of physical trades with index-based pricing was 6.98 times the volume of trades that formed the indexes. In 2008, that ratio was just 3.56, the report said.

Part of the reason for the shift is a gradual erosion in the number of energy companies willing to report trades to index publishers – a voluntary process that firms may stop or start at any time. Last year, 112 companies told Ferc they engaged in price reporting, down from 133 in 2009, the Cornerstone report found.

One reason for the decline in reporting appears to be Ferc itself. The regulator, which oversees wholesale US natural gas and power markets, has stepped up its enforcement activities in recent years, extracting hundreds of millions of dollars in fines over cases of alleged market manipulation. Market participants say the increased risk of an investigation stemming from an improperly reported trade has made a growing number of companies skittish about price reporting.

"We were very much a proponent of price reporting because it helps keep the markets more transparent," says a US-based compliance manager at one energy company that chose to stop reporting in recent years. "But it was just felt that we did not need that type of exposure."

The NGSA's Fordham says that's not an isolated occurrence. "We have heard that a lot of companies have elected to cease reporting due to the perceived regulatory risk," she says.

Index publishers confirm they have seen a reduction in companies' willingness to report, but they stress that the size of the drop-off has been small and that their indexes remain accurate measures of their underlying markets. "While we have experienced a small decline in the number of companies that report transactions, we still see ample liquidity in the natural gas market and Platts is confident that it is able to produce assessments reflective of market value," says Mark Callahan, Platts's Houston-based editorial director of North American power and natural gas pricing.

Index publishers also push back against the suggestion that perceived regulatory risk is driving the fall in reported volumes. The more important factor, they say, is a broad shift away from reportable fixed-price deals and towards index-based pricing. "NGI has experienced some decline in reporting as more companies index and therefore have only de minimis reportable transactions," says Ellen Beswick, Virginia-based publisher and editor-in-chief of Intelligence Press, the parent company of NGI. "We have lost just a couple [of] companies over the last several years who decided not to report for their own business reasons."

The move towards index-based pricing is partly due to reduced volatility in the US natural gas market, which has made gas consumers more willing to buy volumes linked to indexes, rather than locking in prices with fixed-price deals. The changing mix of market participants – particularly the retreat of banks from commodities trading – has also been a contributing factor, index publishers say.

"Many of the banks, which previously would have taken on that risk, have got out of this market," says Caroline Gentry, Houston-based vice president of business development at Argus Media. "The banks like to do fixed-price trading because their goal is to make money. The utilities, and to a certain extent the producers, like tying what they can to index, because there's no risk that they'll buy above it or sell below it."

Even with the decline in reported volumes, index publishers say they still capture a broad enough slice of the market to publish representative prices. In 2014, eight of the 10 largest market participants engaged in voluntary price reporting, according to the Cornerstone report. That included oil majors BP and Shell, whose US trading units were the largest and second-largest participants by volume, respectively.

In all, the volume of trades reported to index publishers in 2014 accounted for 50.2% of all trades that could have been reported, the report said. Still, that percentage has dropped in recent years: in 2011, the figure stood at 58.8%.

Greg Leonard, the Washington, DC-based head of Cornerstone's energy and commodities practice and a co-author of the July 14 report, says it is difficult to say whether the decline in reporting has undermined the reliability of any indexes. Overall, reported volumes appear healthy enough to support the index publishers' efforts, he says. But the Ferc data does not break down reported volumes by index – so it is unclear if the decline has hit some indexes harder than others.

"If you really want to ask the question, 'are the indexes reliable?'... you've got to ask that on an index-by-index basis," Leonard says.