Europe’s energy markets are in chaos. With Ofgem carrying out an investigation in the UK into the way the price of gas is set the European Commission (EC) has raided the offices of Shell, BP, Statoil and Platts as part of an investigation into rigging of the oil price.
The two separate investigations share a common core. Both are based around the way prices are set, not by governments or regulators, but by private companies known as “price reporting agencies” using data partly provided to them by the people who sell the oil and gas.
The price is set based on a relatively small number trades at particular times of day. If firms can find a way to rig these prices then they can influence the price paid by businesses and consumers for most of the oil and gas we consume. There is an obvious incentive to rig the market – but no firm has yet been found guilty of malpractice.
Yet as Ofgem’s protracted investigation in the UK continues firms are losing confidence in the process. Energy companies, banks and other trading firms are running to distance themselves from the price-assessment system which forms the basis of energy contracts from well-head to homes and businesses. As they do so the system itself becomes more and more unreliable.
This week saw confirmation that some of the major players in the gas market – including Centrica, RWE and Statoil – are refusing to continue providing data and quotes to price-reporting agencies (PRAs), thus further undermining the reliability of price assessments used as benchmarks at both wholesale and retail level. Indeed Centrica haven’t supplied information for a few years.
The news comes on the back of growing industry criticism of the incumbent price-assessment system, with analysts, traders and PRA clients increasingly vocal about their belief that energy indices are highly vulnerable to manipulation and malpractice.
Having worked as a price reporter at one such firm - ICIS Heren assessing the UK NBP market (the main price against which gas contracts are bought and sold), these problems are all too familiar.
In fact, they formed a large part of the cache of evidence I disclosed to the FSA, Ofgem and the press when blowing the whistle on suspected manipulation of our key day-ahead index late last year.
In an internal meeting to review our 28 September assessment management told me the firm had no obligation to report attempted abuse to regulators.
“We can’t stop people trying to manipulate the market,” they said “As in move the market, the question of whether we should report it to someone else? We have no obligation to do that, whether we should, or not….”
A former ICIS Heren employee claimed the fact that price reporting agencies make their methodology public – to ensure transparency - could be abused to manipulate prices. He said he'd had conversations with others in the industry who claimed prices were 'fudged'.
“Every company's aware, given that the fact you [ICIS] publish a methodology, you're basically giving people guidelines on how to manipulate a market.”
“He [a contact at an energy company] told me last week that that's what they do... not that he did it in particular, but just that the company may move things to benefit them… he said "now you've left ICIS Heren I can tell you, we [energy company analyst] fudge the prices we give to them.”
The agencies, including ICIS, insist they have robust procedures to spot and remove anomalous trades. But with the pricing process seemingly so easy to exploit, it is little wonder that traders told me ‘it [manipulation] does go on’, setting out in disturbingly detailed fashion how traders from major energy firms manipulate wholesale market prices.
What is more surprising – not to mention wholly unacceptable - is that legislators have let this anachronistic pricing system remain in place for so long.
In the wake of the LIBOR financial scandal, laws were passed by the EU criminalising the manipulation of benchmarks, but over-the-counter (OTC) markets such as the the UK’s wholesale gas market and the global oil market remain beyond the reach of the regulators.
PRAs have trumpeted their own joint-issued code of conduct and self-governance as sufficient protection for energy users, but have faced repeated calls from both inside and outside industry to tighten up their procedures. ICIS launched a consultation in March seeking comments about its current methodology, and received several stern rebukes by way of response, including Statoil’s call for significant amendments in order to “reduce the opportunity for gaming or market manipulation”.
But while the market itself is so poorly policed, and while PRAs remain largely left to their own devices (their only regulation comes from the pan-global IOSCO, who have proved utterly toothless over the issue for years), expecting serious change to sweep through the system is mere wishful thinking.
My meetings with Ofgem over the last six months reveal a regulator with both inadequate comprehension of the market and an insufficient mandate to investigate suspicious activity even if they did understand the system. Key witnesses remain uninterviewed more than half a year after the allegations were brought to Ofgem, and the regulator’s refusal to update the market on their probe has left many convinced they will simply bury the incident indefinitely to avoid any political fall-out.
But the market has spoken – or rather, decided to stop speaking to PRAs – and the knock-on effect spreads far beyond those firms trading gas wholesale. If the very traders active on the OTC market won’t confirm the deals and data they see, then the assessments made by PRAs will become even more unreliable, affecting anyone with an exposure to energy prices all the way down to retail level.
Swift and decisive regulatory action must be taken to redress the situation, as happened after the LIBOR affair was made public, otherwise the system will become too broken to ever be fixed.
