Is FERC Cracking Down on Market Manipulators?

Last October, the Federal Energy Regulatory Commission (FERC) announced that it was seeking a record $470 million penalty against Barclays Bank for manipulating California energy markets for several years in the late 2000s. The amount includes a $435 million fine as well as disgorgement of $35 million in profits Barclays gained from allegedly illegal trading. In addition, FERC levied hefty fines against several individual Barclays traders.

FERC alleged that four Barclays traders violated regulations by engaging in loss-generating trading of next-day fixed-price electricity in order to benefit Barclays’ financial swap positions. The trades resulted in $139 million in losses by other participants trading electricity for California and neighboring states. Essentially, Barclays was accused of playing one market against another, taking losses in physical energy markets in order to make more money on the financial exchanges. (Barclays denies the charges and is currently fighting the fine.)

This action follows a $435 million fine against J.P. Morgan last July. A FERC investigation concluded that the bank was exploiting loopholes in California market rules to boost its profits and then supplied false information in the subsequent investigation. In addition to the fine, J.P. Morgan was banned from physical power trading for six months.

To put these fines in perspective, Barclays was fined a total of only $453 million in a settlement over its manipulation of the London interbank offered rate (LIBOR—a key benchmark in international lending), a scandal that created a major international incident and, some alleged, threatened the foundation of the world financial markets.

FERC Exercises Market Muscle

If it seems as if FERC is exercising more of the authority over market manipulation that Congress gave it with the 2005 Energy Policy Act, it is. The percentage of enforcement actions devoted to market manipulation has risen substantially in the past three years, since current Director of Enforcement Norman Bay took over.

More significantly, FERC in April created a new Division of Analytics and Surveillance for the express purpose of better detecting and catching market manipulation. The division’s mission is to conduct “forensic analysis of complex market data and information to assist in determining whether manipulation or other improper conduct occurred or is occurring.” And to help it do its job, FERC issued two orders requiring regional transmission organizations and independent system operators to submit a wide range of data on energy trading, as well as expanding the scope of entities that are required to submit Energy Quarterly Reports on their power sales and transmission service.

In addition to the Barclays and J.P. Morgan fines, FERC has levied several other large penalties against market manipulators in the past year.

Banks Leave Power Markets

The reaction in the financial markets is about what you’d expect: wholesale retreat by the big banks. In 2008, banks were responsible for about 15% of the physical power market in the U.S. In 2012, it had fallen to under 7%. Some of this is due, of course, to the 2008 financial crisis and the retrenching, reorganization, and new regulatory oversight that followed it. But combined with the new attention from FERC, many banks are deciding that power trading is no longer worth the risks.

So is FERC on a crusade against the banks?

If you ask FERC—which many have—it says no. “We’re an equal-opportunity enforcer,” FERC Chairman Jon Wellinghoff said at an event in December. “We’ll go after anybody who we believe is engaged in an activity that is inappropriate or is in violation of the statute. That’s why Congress gave us that authority to actually have some teeth in the law to be able to police the industry and police the markets.”

Still, its 2012 Report on Enforcement, released in November, begins with some stern language that should give electricity traders a certain amount of pause. In explaining its enforcement priorities, the report notes:

Conduct involving fraud and market manipulation poses a significant threat to the markets overseen by the Commission…. Similarly, anticompetitive conduct and conduct that threatens market transparency undermine confidence in the energy markets and harm consumers and competitors. Such conduct might also involve the violation of rules designed to limit market power or to ensure the efficient operation of regulated markets.

“Of particular concern,” it goes on, are cases “where there is often significant gain to the violator.”

The report notes that FERC settled three enforcement actions related to market manipulation in 2012, one in 2011, and none in 2010. Between 2007 and 2009, it settled two.

One of the 2012 settlements concerned allegations that the Constellation Energy Commodities Group (CECG) engaged in behavior similar to that alleged against Barclays: making unprofitable trades to affect the market in order reap greater returns under other derivative instruments it held. Though it denied any wrongdoing, CECG agreed to a $135 million fine and the disgorgement of $110 million in profits, an amount that was—at least until the Barclays and J.P. Morgan cases settle—the largest penalty FERC had ever assessed.

Crusade or not, it’s clear FERC is focusing increased attention on energy trading.

— Thomas W. Overton, JD, is POWER’s gas technology editor. Follow Tom on Twitter @thomas_overton