The Federal Energy Regulatory Commission (FERC) recently reached settlements in two high-profile cases alleging price manipulation in natural gas markets. These settlements likely reflect a more reasoned approach at FERC toward allegations of price manipulation. In Amaranth Advisors L.L.C. et al., FERC and the Commodity Futures Trading Commission (CFTC) jointly accepted a settlement of $7.5 million in civil penalties. In Energy Transfer Partners et al., FERC accepted a settlement of $5 million in civil penalties and a $25 million fund to disgorge alleged unjust profits to parties filing claims. Energy Transfer had earlier reached a settlement with the CFTC for $10 million.
These settlement amounts, although substantial, are much less than FERC originally sought. In July 2007, in the Amaranth case, FERC sought civil penalties of $200 million and disgorgement of $59 million in unjust profits plus interest. In 2008, the Commission turned down a proposed settlement because the civil penalties were not large enough given the alleged unjust profits. Also in July 2007, in the Energy Transfer case, FERC sought $82 million in civil penalties and disgorgement of $67 million in unjust profits plus interest. In litigation, FERC staff increased its estimates of the alleged unjust profits to $80 million.
In addition to the timing and the fact that FERC accepted much less money than it originally had sought, the cases had other similarities. Both cases dealt with allegations that the companies held positions in a derivative instrument that gave them an incentive to sell natural gas at lower prices. Amaranth was short in derivative NYMEX look-a-like contracts that settle based upon NYMEX future price settlements. FERC alleged that Amaranth sold NYMEX future contracts during the settlement period at artificially low prices in order to reap gains on the look-a-like contracts. Energy Transfer was short in derivative Houston Ship Channel (HSC) basis swaps that settle based upon monthly gas prices at HSC. FERC alleged that Energy Transfer sold physical gas at HSC at artificially low prices to reap the gains on the derivative basis swaps. Hence, both cases dealt with allegations of companies selling natural gas at lower prices, not higher prices.
Both cases also did not involve any trading behavior that is per se objectionable. A number of trading activities are clearly considered to be manipulative and are generally forbidden. For example, cornering a market— that is, controlling all of the potentially deliverable supplies for a futures contract—can allow a trader to sell at artificially high prices. Such behavior is recognized as manipulative, and specific rules are designed to prevent it. But FERC did not allege that either Amaranth or Energy Transfer did anything that was manipulative by itself. In fact, if Amaranth and Energy Transfer had not held short positions in derivative instruments, FERC would have had no objection at all. FERC also did not claim that Energy Transfer sold at a loss, or in other words that the revenue received from selling the gas was less than the cost of supplying the gas. Nor did FERC claim that Energy Transfer violated any trading rules. Furthermore, the respondents in both cases showed that other traders at other locations or in other periods exhibited generally similar trading behavior.
Both cases involved the effects of hurricanes Katrina and Rita. Although the Energy Transfer case ultimately led to allegations involving trades that occurred in 17 months of a 25-month period, the investigation originated with a single complaint about trading on September 28, 2005 and the vast majority of the alleged effects occurred from September through December of 2005. This period is when markets were in the most turmoil due to the hurricanes and their aftermath. During such periods, it is not surprising to have substantial and unexpected changes in prices. FERC’s case amounted to claims that prices should have increased more in Texas immediately after the hurricanes, and prices should have remained high in December 2005 despite the post-hurricane recovery. The Amaranth case dealt with trading in March, April, and May 2006. In these months, prices were generally falling as gas supplies continued to recover after the hurricanes. Hence, it would not have been surprising to have lower prices when Amaranth sold its futures contracts, regardless of Amaranth’s behavior.
Finally, both cases involved causation issues that cast significant doubt on FERC’s allegations. The alleged manipulative selling behavior may not have caused the actual transaction prices. For example, Energy Transfer used similar selling strategies in many months. FERC alleged manipulation in some of those months, but not in others. What caused the difference in prices between the allegation months and the non-allegation months? If it was not a difference in selling strategies, then the difference must be the result of other supply and demand factors. And if the other supply and demand factors are determining the prices, how can it be that Energy Transfer manipulated the prices? A seller that cannot cause actual transaction prices to be different cannot be said to sell at artificially low prices. Similarly in the Amaranth case, it is not clear that Amaranth’s behavior reduced prices. Indeed, despite Amaranth’s sales, prices in one month actually rose during half of the period in which contracts settled.
The settlements reflect a change at FERC. The Amaranth settlement apparently was available in 2008 when Staff and Amaranth reached an agreement that was rejected by FERC. FERC also might have settled earlier with Energy Transfer. Trade press reported in 2006 that Energy Transfer was willing to settle, and in 2007 Energy Transfer reached a settlement with the CFTC over allegations about trading in September and November 2005.
The reason for FERC’s change in position is not clear. It is possible that additional litigation and discovery revealed weaknesses in FERC’s allegations that were not previously apparent to FERC (but apparent to Amaranth and Energy Transfer). It is also possible that the new administration decided not to pursue further allegations against companies charging relatively low prices when energy prices were at historically high levels. Regardless, the settlements indicate FERC’s willingness to put legacy cases behind it and move on to a new agenda.