A recent discussion paper by The Brattle Group titled “Losing Money to Increase Profits: A Proposed Framework for Defining Market Manipulation” goes a long way towards articulating a practical definition of market manipulation.  The question is not merely theoretical.  Regulators need to know what to look for and how to build a solid enough case to reliably prosecute instances of market manipulation.  In addition, the regulated community needs to know what market manipulation is in order to build effective compliance programs to prevent its occurrence.

The Brattle Group’s definition makes a lot of sense.    It asserts that market manipulation occurs when an entity intentionally loses money on a price-setting transaction to benefit related positions in price-taking transactions.  Selling physical natural gas at a loss to help drive down an index price in order to make a profit on transactions that are priced at the index should be considered manipulation.  The Brattle Group’s discussion paper explains how the definition could be applied and used, as well as a variety of situations to address the circumstances commonly understood to be market manipulation.  I think it would be beneficial for all of the agencies (FERC, CFTC, FTC, and SEC) to consider adopting a common definition for market manipulation and to look closely at The Brattle Group’s proposal.

The definition, however, raises one interesting issue—what happens when the price-setting transaction is regulated by one agency and the price-taking transaction is regulated by another agency?  Which agency has jurisdiction to prosecute the manipulation?  The FERC and the CFTC have been at odds over jurisdiction ever since FERC instituted proceedings against Amaranth Advisors for allegedly manipulating exchange-traded natural gas futures (regulated by the CFTC) because the futures index sets the price of physical natural gas sales (regulated by FERC).

In order for The Brattle Group’s proposed definition of market manipulation to succeed, the agencies would have to agree on how to proceed when more than one regulator is involved.  When an entity intentionally loses money selling physical natural gas at Henry Hub in order to drive down the Henry Hub index price because it would benefit the entity’s futures position at Henry Hub, which agency would prosecute the manipulation scheme—FERC, CFTC, both?

I suggest that the agency that regulates the price-setting transaction would have primary jurisdiction to prosecute the manipulation, with the agency that regulates the price-taking transaction assuming a supporting role.  The agency that regulates the price-setting transaction would have a better understanding of when a loss would be explained by legitimate business purposes or when that loss is the trigger for a manipulation scheme.  In the example above, FERC would have primary jurisdiction to prosecute an alleged manipulation based on losses on physical natural gas sales in order to benefit a position in the futures market.  If the situation were reversed (the losses were in the futures market to benefit physical sales positions), the CFTC would have primary jurisdiction.  However you may come out on this question, one agency only should take the lead so that all parties—regulators and regulated alike—know the rules of the road.

The footprint now is fairly small.  In addition to the wellhead, there is a small building and tower for the SCADA and automatic shut-off control facilities, a few tanks for the water that comes back out of the well, and the interconnection for the gathering pipeline that takes the natural gas to the custody transfer station with Atmos.  The return water is quite salty. They dispose of it in a salt water disposal well they had drilled a few thousand feet down.

From there, we headed over to a site where they were actually drilling a well.  It was located in a commercial/light industrial section near the airport. They had erected 16 foot sound barriers, but the rig rises 145 feet into the air, clearly visible from the street.  The use the same drill pad to drill anywhere from 8-24 horizontal wells.  Once, they complete a lateral, they move the rig a few feet and drill a new well bore for a lateral a few degrees in another direction, like the spokes of a wheel.

It’s amazing how much can be produced from such a small footprint.

Editors note: We’re including some photos from the event with Andrew’s post. Enjoy and let us know if you were there in the comments below.

The abundance message is beginning to build momentum.  As Rick Smead, from Navigant, noted, the Society of Petroleum Engineers recently reported that there are over 16,000 Tcf of shale gas resources globally and that North America has more of it than anywhere else in the world, over 3,600 Tcf.  He also noted that while only about one-quarter of those resources are currently technically recoverable, advances in drilling and recovery methods will, over time, unlock more and more of that resource base.

So, why aren’t we using natural gas more – to heat more of our homes and businesses, as a low-carbon fuel to generate electricity, to integrate intermittent, renewable resources, and as a transportation fuel for fleet and person vehicles, for ships in port, for long-haul trucks, etc.?  One of the key take-aways from today’s sessions is that it’s time for the industry to focus on the demand side of the equation – to look at ways to increase demand for natural gas.  AGA is involved in a number of efforts to do just that.  And, we have a great message from our Chairman – “GAS IS GOOD.”

Interestingly, it was the tax portion that touched off some of the most interesting discussion.

Who owns the gas?

Depending on where you are in the country, the mineral rights to produce natural gas found under the ground could be owned by the Federal government, the state government, or a private landowner, and in some cases a surface owner would not own the mineral rights for gas found under the property he or she holds.

I had an interesting conversation with a delegate from Poland who was surprised at the land ownership structure in the United States.  Apparently in Poland, land is held by private landowners, i.e., the government does not generally own land; however, the landowner essentially owns only the surface rights, and government does own the mineral rights.  The delegate was describing how difficult it is to build pipelines to bring produced gas to market.

With so many landowners to negotiate with and few tools such as eminent domain, I can only imagine the challenges in trying to get infrastructure built there.

Here in the United States, we should count our blessings.  While there are difficulties and challenges in working with various landowners, for the most part the climate for building natural gas infrastructure is favorable.

We have all benefited from the tens of thousands of wells, thousands of miles of pipelines, and hundreds of Bcf in storage capacity that have been built even in the last decade.  Our natural gas infrastructure provides a solid platform for meeting growing energy demand in an environmentally responsible manner.  It’s helpful to be reminded of that every once in a while.

In general, DOE is proposing to use full-fuel-cycle measures of energy and greenhouse gas emissions, rather than the primary energy measures it currently uses.  DOE is also proposing to work with the Federal Trade Commission to make full-fuel-cycle energy and emissions data available to the public to enable consumers to make cross-class comparisons.  DOE is proposing this policy change to implement the recommendations of the National Academy of Sciences that DOE consider moving over time to use of a full-fuel-cycle measure of energy consumption for assessment of national and environmental impacts, especially levels of greenhouse gas emissions, and to providing more comprehensive information to the public through labels and other means, such as an enhanced website.  DOE is soliciting public comment on its proposed policy, its methods for modeling energy consumption and emissions impacts, and the ways in which this information can be disseminated to the public.

DOE will hold a public meeting on its proposal on Thursday, October 7, 2010, from 9:00 a.m. to 4:00 p.m. EDT, in Washington, DC, and will accept written comments from interested parties up to October 19, 2010.

These issues came up at the AGA Federal Energy Regulatory Commission (FERC) Manual Users Forum held March 31, in AGA’s offices in Washington, DC.  The Forum was held to roll out the AGA FERC Manual: A Guide for Local Distribution Companies, a comprehensive guide to the FERC’s regulation of the natural gas industry with a particular focus on the needs and perspectives of gas distribution utilities.  The Manual was written by lawyers at Dewey & LeBoeuf LLP and is available for sale to the general public via AGA’s Web site.

Answering the question above usually entails trying to separate as much as possible the prosecutorial role from the adjudicatory (judge and jury) role.  The idea is that in order to ensure fairness, or at least the appearance of fairness, the same person should not both prosecute and ultimately decide an issue.  In FERC’s case, a separation of function rule applies once a case has gone to hearing before an administrative law judge that prevents the enforcement staff involved in a particular investigation from advising the Commissioners.  The intent is to put enforcement staff on equal footing with the subject of the investigation both before the administrative law judge who must determine the facts and the Commissioners who must ultimately decide the issues and impose any remedies.  Some would argue that the separation should occur even earlier and apply during the preliminary stages of the investigation.

Former FERC Commissioner, Suedeen Kelly (the keynote speaker for the Forum), however, suggested that a separation of functions ends up vesting the prosecutor with greater power because the Commissioners may be less able to provide a supervisory role over enforcement staff as to whether an investigation should be brought in the first place or otherwise guide the conduct of the investigation.  She makes a good point.  I firmly believe decision-makers at FERC at all levels must be held accountable for their actions.  But, how do Commissioners hold enforcement staff accountable while at the same time remaining impartial to decide enforcement matters?  This is an issue that admits of no easy answers and one that I think FERC and the industry will struggle with for some time.

In the Energy Policy Act of 2005, Congress gave the Federal Energy Regulatory Commission (FERC) powerful enforcement authorities, including the ability to assess civil penalties of up to $1 million per day for violations of any FERC rule, regulation or order.  Users of pipeline services, in general, and gas utilities, in particular, have been the subject of a large number of FERC enforcement settlements in which civil penalties have been assessed.  These settlements have focused on the interstate transportation and sale of natural gas by LDCs, the relationship of an LDC to its affiliates, and LDCs as shippers on interstate pipelines.

In response to this increased scrutiny, AGA, with the support of over 30 sponsoring members, has published the AGA FERC Manual: A Guide for Local Distribution Companies.  The Manual, written by lawyers at Dewey & LeBoeuf LLP, is a comprehensive guide to FERC’s regulation of the natural gas industry.  It was intended to be one of the first places to which industry participants can turn for quick answers about FERC’s rules as well as for more detailed explanations and guides to additional research.  It was also written with the front line employee involved in buying and selling wholesale natural gas and arranging transportation and storage transactions in mind.  Its language is straightforward and not overly legalistic.

While the Manual was developed for AGA members with the needs of gas utilities in mind, anyone involved in the wholesale natural gas markets would find the Manual useful.  It broadly discusses rules regarding buying and selling natural gas, obtaining and releasing pipeline and storage capacity, preparing compliance plans, and other topics of general interest to natural gas market participants.  A set of DVDs accompanying the Manual contain lectures on each of the major topics of the Manual that are useful for training.

We hope that users of the Manual find it a valuable tool for building and maintaining a robust plan for compliance with FERC rules and regulations.

Supply diversity is important both within and across fuels.  I often hear people advocate that we should generate electricity with: ___ (pick your source – wind, solar, fuel cells, nuclear, natural gas, etc.). But in my view, we need a diverse electric generation fleet that draws from ALL sources of supply in order to mitigate the impacts of price volatility in any one particular fuel source.  I think a large part of our concerns about the price of oil and our dependence on foreign sources of it stems from the fact that nearly all of our transportation needs are met by a single fuel source.  According to the Energy Information Administration’s 2008 Annual Energy Review, the transportation sector relies on petroleum products to supply 95 percent of its needs.

Even within a fuel type we need a diverse resource base.  As my colleague, Chris McGill, has said, when it comes to natural gas, North America is blessed with resource abundance.   And that abundance is diverse geographically and geologically.  Whether on-shore or off-shore, conventional or non-conventional, we are fortunate that we have many sources of natural gas supply to meet our energy needs.  And, that diversity has helped keep natural gas prices low for consumers.  For example, in 2005 when hurricanes shuttered much of our off-shore natural gas production, prices rose dramatically in response to the supply constriction. In 2008, however, when off-shore supply was again taken off-line due to hurricanes, natural gas prices fell.  What changed?  On-shore production from new shale plays as well as increased LNG imports more than made up the supply shortfall.  Indeed, according to Pan EurAsian Enterprices, Inc., increased LNG imports this winter helped stabilize natural gas prices in New England.  See AGA’s Natural Gas Market Indicators (Feb. 26, 2010).

I believe that our ability to import natural gas via LNG import terminals is an important element of our diverse natural gas resource base that helps keep natural gas prices affordable for consumers.  Several U.S. Senators have introduced legislation (S. 3056) that would remove from the Natural Gas Act provisions that make clear that the Federal Energy Regulatory Commission (FERC) has exclusive jurisdiction over the siting of LNG import terminals.  The Natural Gas Council, of which AGA is a member, opposes this legislation with good reason.  The legislation, if passed, would create uncertainty in the siting process and may ultimately lead to fewer import facilities being sited or built.  While some local interests might cheer at that result, in the long run we only hurt ourselves by chipping away at our natural gas supply diversity.

We should not put artificial limits on LNG imports.  The market should decide where and how many of these facilities should be built, with FERC ensuring that each facility is sited and constructed in an environmentally responsible manner.   For the benefit of all natural gas consumers, we should not remove one of the “baskets” that has contributed to our diverse natural gas resource base.

As several have suggested, the significance of this ruling is far greater than the individual FERC proceeding involved and even greater than the case AGA had thought it was bringing to the court.  On its own, the court focused on FERC’s failure to address the arguments raised in dissent by then-commissioner, now-chairman Jon Wellinghoff.  This case will stand as precedent for all Federal agencies that, as a matter of administrative law, agencies must address the arguments raised by their dissenting commissioners.  Failure to do so will make their orders vulnerable to a court challenge.

A recent article in Inside FERC (“Court stance on FERC dissents seen as unworkable”) suggests that the ruling could adversely impact the decision-making process at FERC.  The article noted that, unlike courts, dissents in FERC cases are normally not circulated in advance.  Former FERC Chairman Joseph Kelliher was quoted as discussing the difficulty of requiring commissioners to supply a dissent in advance and the potential damage to comity among the commissioners of “gamesmanship” associated with the timing of supplying the dissent.

I take a contrary view.  I believe that the ruling will actually strengthen the decision-making process at FERC.  In the article, both Kelliher and former FERC general counsel William Sherman acknowledged that even though dissents are not normally circulated in advance, the views of a dissenting commissioner are generally known before the order is voted on.  Therefore, the ruling will simply require the majority to pay a little more attention to them.  During the deliberative process, the chairmen and staff will need to know when a commissioner will dissent and what the fundamental concerns are.  That can only help the process.  When I worked for former FERC Chairman Pat Wood, it was part of my job to know when a commissioner would dissent and what the dissent would say.  Pat told me he wanted to know because “I may agree with them.”

The concerns that have been raised regarding the potential for delay or gamesmanship can be easily addressed.  First, problems can be fixed on rehearing.  A large part of FERC’s vulnerability in the orders that led to the court’s decision stemmed from the fact that FERC waited until the rehearing order to even address AGA’s arguments, and it was the rehearing order to which Wellinghoff dissented.  FERC can reduce the impact of this ruling if it adequately addresses the arguments that are raised the first time around.  The dissent will have been revealed initially, which FERC can address on rehearing.

Second, even if the press of business prevents full consideration of all of the arguments initially and a dissent surfaces in a rehearing order, voluntary remand is available.  In any court case, FERC has an opportunity to seek a remand of the orders for which judicial review is sought in order to further consider them and even provide additional support and reasoning for its decisions.  The FERC solicitor can review the orders that have been taken up and, if there is a dissent, make a determination if the arguments were adequately addressed.  If additional reasoning is needed, FERC can seek a voluntary remand.

In the end, the court’s opinion should stand for the proposition that an agency must adequately justify its decisions, even when the challenge comes from one of its own commissioners.  The outcome of the court’s opinion should be better, more well-reasoned agency decisions.

The commission comprises five members who serve staggered, five-year terms.  No more than three commissioners may be of the same political party.  With Norris’ confirmation, FERC now has four commissioners:  Phil Moeller, a Republican, has been on the commission since 2006, and his term expires this year (June 30, 2010); Marc Spitzer, also a Republican, joined the commission shortly after Phil Moeller, and his term expires next year (June 30, 2011); John Norris, a Democrat who was recently confirmed, will serve a term ending June 30, 2012; and Jon Wellinghoff, also a Democrat, serves as chairman of the commission, and his term will end June 30, 2013.  There is an open seat with a term expiring June 30, 2014.  This seat was recently vacated by Suedeen Kelly, who had been on the commission since 2003 but declined President Obama’s invitation to serve for another five years.

Serving as a FERC commissioner is a demanding job – the workload is heavy, the policy calls are significant and the demands on one’s time from interested parties wanting to hear and express views are never ending.  There should be five commissioners to spread the work around.  While the commission can function with four and even three commissioners, the decision-making process is improved when different perspectives and opinions are brought to bear on the myriad policy calls that arise on a daily basis.  Having only four commissioners means that every decision must command a three-fourths majority, and although the issues with which FERC deals do not usually break along partisan lines, having two Republican commissioners and two Democratic commissioners only invites partisan considerations.

I look forward to John Norris’ term on the commission and wish him the best.  I hope that President Obama soon nominates someone of high quality to fill the open seat and that the Senate confirms him or her shortly thereafter.  To be truly effective the Commission should have a full complement of five commissioners.