The FSA and Ofgem have launched an investigation into the alleged manipulation of the NBP wholesale gas price by one or more of the UK Big 6 (Centrica, SSE, RWE, E.On,, EDF & Iberdola) following claims from a whistleblower published in the media. The allegedly suspicious trades occurred on the 28th September when a number of trades took place at below the prevailing market trend.

Trades on the day-ahead gas market (28th Sept 2012) – The Guardian

All the major energy suppliers in the UK have issued statements confirming that they condone any market manipulation and wish to see an open and transparent market.

Comment and analysis

The suggestion at the heart of this alleged trading malpractice is that parties were looking to manipulate the agreed settled price for Winter gas by trading well below the prevailing market. Trades can occur outside market prices for many number of reasons, for example, simple fat fingers mistakes which merit no media coverage and indeed are either reversed or any profit or loss is taken on the chin. Broadly speaking a market can agree to price  for an asset in two broad mechanisms;  we could look at the weighted average price that a product traded at or we could look at the very last price someone was willing to buy or sell that asset for. Both have advantages and disadvantages; the weighted average price catches the entire life of that product but means that large movements in the past may impact the final price, whilst agreeing a price based on the last trade means that is more reflective, at least in theory, as to the people actually value product at.

Since the Heren index is set at the last price a product was traded, the accusation is that certain market participants, and we don’t know who this stage, were looking to influence the market by making a series of very late trades. The suggestion is that Winter 12/13 gas was trading in a range of 58.5-59.5p/therm throughout the day and yet just before it is about to fix its final price, six trades were entered well below market. The drove the final price to 58p/therm.

Because these trades fell below-market it is likely that no consumer would have directly have lost out; indeed, one could argue, that consumers were actually beneficiaries of this since the market price is being set at a lower level than it would otherwise have been. Why would someone want a lower market price the gas? Clearly, if you’re short,  or have a derivative product that gives you such an exposure, it would be in your interest to see a lower price for that product. The data as it currently stands neither supports nor refutes a suggestion of market manipulation.

An obvious question to ask is how does this price get set? There are a couple mechanisms by which wholesale gas prices can be transmitted to the market. In a sense, the most transparent is for trading to occur anonymously through an exchange; the exchange can monitor and observe prices and therefore report an agreed market price. An exchange however will not in itself prevent manipulation,  since there’s nothing stopping two counterparties agreeing off-exchange prices and then transacting on the exchange. This would, of course, be in breach of the exchange rules. Prices can also be discovered by pricing agencies contacting market agents and asking what trades they have done and at what price. These Over-the-Counter trades (OTC) are direct agreements between Company A and Company B in which neither party is required to make the details public. It is accepted practice that when asked an OTC counterparty will give broadly indicative prices with reporting agencies taking averages of the prices to account for outliers. The ‘Libor’ scandal shows how the potential for participants to manipulate price quotes is a strong one and this is especially true in more illiquid products.

All of the Big Six have categorically stated that they take no part in market manipulation. However, political pressure on the energy utilities is already high in the UK due to recent tariff rises and any suggestion, proven or not, will have significant adverse effect upon their reputations. The UK public have up-until this point been fairly acquiescent as their energy bills have risen and complaints have been muted rather than expressly vocal. However, the Big Six should not take that as a sign that there is no discontent as a rejuvenated Ofgem/FSA along with mounting political pressure and upcoming energy market reforms place considerable downside risk upon them.


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