United States: Discussion of the Effects of Domenici-Barton Energy Policy Act of 2005: Title III- Price Reporting and Transparency

On August 8, 2005, President Bush signed into law the Domenici-Barton Energy Policy Act of 2005 ("Domenici-Barton" or "the Act"). This Legal Alert summarizes the provisions in Title III of the Act related to natural gas price reporting and price transparency, in the context of related events in the last two years. As discussed below, Domenici-Barton adopts the approach from the underlying Senate Bill and allows, but does not require, the Federal Energy Regulatory Commission ("FERC"), to promulgate new regulations mandating natural gas price reporting.

Scrutiny of natural gas price indices in 2003 stemmed from disclosures that some natural gas traders intentionally tried to manipulate these indices through the false reporting of price data (primarily to the industry trade publications such Platts and Natural Gas Intelligence).¹ These revelations led to widespread distrust of the price indices and also led to some industry participants withdrawing from the reporting process. In turn, the drop in the number of reporting parties and reported transactions fostered increased skepticism of the price indices and, at times, made it impossible for the trade press to compile indices for some pricing points. Finally, these events led to significant scrutiny from FERC as well as significant political pressure from Capitol Hill demanding improvements in the reporting process.

On March 14, 2003, FERC Staff issued a "Notice of Staff Technical Conference" to discuss issues related to the adequacy of natural gas price formation.² The conference, held on April 24, 2003, was intended to address "ways to fix deficiencies in the manner price data are currently collected; how to increase reliability; and what alternative models might produce reliable natural gas price discovery."³ At the Conference, senior FERC Staff as well as representatives from the Commodities Futures Trading Commission ("CFTC") heard testimony from trade press, the electronic exchanges, industry representatives and others on how to improve the reporting process and market transparency, and restore confidence in the natural gas price indices. During this Conference, three lightening rod issues emerged: (1) whether government (FERC or some other agency) should step in and take over the gas price reporting process; (2) whether reporting trades to price index developers and publishers should be mandatory; and (3) whether disclosure of counterparty information should be mandatory.

A subsequent FERC Staff Technical Conference & Workshop on Energy Price Discovery & Indices was held June 24, 2003, in conjunction with Staff and Commissioners from FERC, the CFTC and the National Association of Regulatory Utility Commissioners.⁴ The purpose of the June 24 Technical Conference was to continue the price indices debate and address the questions raised in the June 13, 2002, "Staff Paper on Price Formation Issues" ⁵ concerning the proper role for the FERC in price data collection, whether reporting of price information should be mandatory and whether the FERC should authorize price reporting entities or otherwise delegate any regulatory function related to price gathering to a third party.

Prior to the June 24 Technical Conference, representatives of many segments of the industry met in Kennesaw, Georgia to attempt to reach a consensus on a number of areas of agreement with regard to the price indices debate in order to present an industry solution at the June 24 Technical Conference. For example, the areas of agreement included:

1. Data collectors and providers shall adopt corporate codes of ethics that are available to the public;
2. Data collectors and providers shall submit to an annual certified audit to ensure compliance with all protocol elements;
3. Data collectors shall disclose price collection and dissemination methodology;
4. Data collectors shall report at each pricing location total volume, number of transactions and counterparties, and high, low and weighted average prices;
5. Data providers will ensure that trading data are reported by someone other than a trader with a personal financial interest in the trade itself; and
6. Data providers will report price, volume, buy/sell indicator, location, transaction date and term for each reportable transaction. Also, these transactions will be reported individually and not on an aggregated basis which means no manipulation through aggregation will be possible.⁶

Although the reporting process was not intended to be mandatory under this framework, the industry stakeholders agreed that any data provider that elects to furnish information must submit information on all eligible buys and sells (no cherry-picking). Furthermore, the industry stakeholders agreed that the role of FERC should not be expanded but that it should perform a surveillance function and investigate as necessary.

Despite significant agreement reached in Kennesaw, the industry stakeholders continued to disagree on the following: (1) the mandatory reporting of buys and sells; (2) the mandatory reporting of counterparty information; and (3) the implementation of a single data hub versus multiple data hubs. The "Consensus Document" outlining the areas of agreement and disagreement was sent to FERC for discussion at the June 24 Technical Conference.

At the June 24 Technical Conference it was clear that the level of concern regarding the current indices varied among the participants. On one hand, some participants still felt that the indices were "mortally wounded"⁷ and required drastic changes; on the other hand, some participants believed that confidence in the indices had been "winged a little bit"⁸ but could be restored without an overhaul to the reporting process. During the discussions, FERC and others heard testimony from third party index providers (and those aspiring to be third party index providers), representatives of the industry stakeholder group that supported the Consensus Document, current index publishers, a representative from the Committee of Chief Risk Officers and companies that were no longer reporting. As with the last public conference, three polarizing issues remained – mandatory reporting of buys and sells, mandatory reporting of counterparty information and whether there should be a single data collector or multiple data collectors.

The numerous public conferences, staff reports, industry submissions and written comments culminated in the issuance of a FERC Policy Statement on natural gas and electric price indices issued July 24, 2003,⁹ which builds on the consensus views of many industry stakeholders.¹⁰ Importantly, the Policy Statement did not mandate reporting of trades or counterparty information, nor did it require the implementation of a single data hub for purposes of collecting and disseminating price data. However, the Commission warned that if confidence in the indices was not restored, FERC could pursue these additional options.

In particular, the Policy Statement required price index developers to adopt the following minimum standards for creation and publication of any energy price index:

1. Code of conduct. Develop, adopt and publish a written code of conduct disclosing how the index developer will obtain, treat and maintain price data.¹¹
2. Completeness. Index developers are required to obtain complete information for the individual transactions (not to include counterparty data).¹²
3. Data verification, error correction and monitoring. Index developers should verify price data by, for example, matching buys and sells and contacting data providers about any data discrepancies.¹³ Developers should request counterparty identities if necessary to resolve data discrepancies and errors discovered after publication should be corrected. Finally, a developer should have monitoring and surveillance systems in place to identify activity that may reflect an attempt to manipulate prices indices.
4. Verifiability. Developers should undergo an independent audit or verification of its processes at least once each year.¹⁴
5. Accessibility. All interested customers should have reasonable access to published price reports on a timely basis.¹⁵

Moreover, the Policy Statement required that data providers adopt the following minimum standards for reporting transactions data to index developers:

1. Code of conduct. Each provider must develop, adopt and make public a code of conduct for its employees to follow in buying or selling of natural gas or electricity, and in reporting data from such transactions to the price index publishers.¹⁶
2. Source of data. A provider should have trade data reported by a department of the company that is independent from, and not responsible for, trading.¹⁷
3. Data reported. Subject to a confidentiality agreement, data providers should report each bilateral, arms-length transaction between non-affiliate companies in the cash market at all trading locations (not to include financial hedges, financial transactions, swaps or exchanges).¹⁸ For each transaction, the data providers should provide, price, volume, buy/sell indicator; delivery/receipt location, transaction date and time and term. Any errors identified should be corrected as soon as practicable.
4. Error resolution. A data provider is required to cooperate with the error resolution process developed by the index developer.¹⁹
5. Data retention and review. A data provider must maintain all records related to reported transactions for three years.²⁰ The data provider should have an independent auditor review the implementation of and adherence to data gathering and submission process adopted by the company at least once annually.²¹

In addition, the Policy Statement included a safe harbor provision and created a rebuttable presumption that companies and individuals that report trade data to index developers in accordance with the standards set forth in the Policy Statement are doing so in good faith.²² Moreover, the Commission assured data providers that they would not be investigated or subjected to administrative penalties for inadvertent mistakes made in the course of reporting data.²³ The Commission, however, made it clear that it will either prosecute or refer to others for prosecution, companies that violate the good faith standards and, for example, intentionally submit false, incomplete or misleading information to index developers.²⁴

Subsequent fact-finding by the Commission lead to the conclusion that the Policy Statement, along with the concerted efforts by the industry stakeholders, had addressed the previous concerns with price transparency and that no further action by FERC was necessary at that time.²⁵ However, FERC Staff was directed to continue monitoring price formation and to report the results to FERC in its next State of the Markets Report. The political focus on price transparency and price reporting continued into the 109^th Congress and the discussions surrounding the energy bill.

Given this extensive history and the fact that FERC seemed satisfied with the level, as well as the accuracy, of price reporting, many observers were surprised to find that the energy bill voted out of the House Energy and Commerce Committee and later approved by the House contained language directing FERC to establish regulations mandating price reporting for all entities under the Commission’s jurisdiction, except for buyers and sellers having a de minimis market presence and except for natural gas sales by a producer of its own natural gas. The Senate language was more permissive, allowing, but not requiring FERC to impose price reporting requirements on all natural gas buyers and sellers (not just those subject to the Commission’s jurisdiction). (The Senate version also provided for an exemption for de minimis market participants.)

The language that emerged from the House Senate Conference and now enacted into law is a hybrid of the House and Senate versions. Of particular note, however, Domenici-Barton does not require FERC to establish new price reporting regulations or to otherwise establish any new regulations to improve natural gas price transparency. However, if FERC decides that any such new rules and regulations are necessary, Domenici-Barton gives FERC the clear authority to obtain necessary information from any market participant, not just those entities previously under FERC’s jurisdiction. FERC is also given the authority to establish an electronic information system for price collection and price publication in the event that the existing price publications are not "adequately providing price discovery or market transparency." Also of note, the Conference retained the provision exempting de minimis market participants from complying with any reporting requirements FERC might establish.

Recent statements by FERC Chairman Joe Kelliher expressing confidence in the price indices indicate that, at least for the near-term, FERC is unlikely to rely on Domenici-Barton to promulgate new price reporting regulations.

© 2005 Sutherland Asbill & Brennan LLP. All Rights Reserved.

This article is for informational purposes and is not intended to constitute legal advice.