Presented to: EarthSat/PIRA Spring 2004 Energy Conference New York, NY May 18, 2004 Gas Market Monitoring: Past Winter Update William F. Hederman, Director Office of Market Oversight and Investigations Federal Energy Regulatory Commission WH/BF/TG 5/18/04

2 Outline Introduction to FERC’s OMOI Enhancing Confidence Report on Natural Gas and Electricity Price Indices Review of the New England Cold Snap Next Steps

3 FERC has a 3-pronged strategy. Effective Rules Infrastructure Rules Enforcement Competitive Markets Just & Reasonable Outcomes Strategic Approach

Director Office of Market Oversight and Investigations (OMOI) Division of Management & Communication Division of Management & Communication Deputy Director Market Oversight & Assessment Deputy Director Market Oversight & Assessment Deputy Director Investigations & Enforcement Deputy Director Investigations & Enforcement Hotline Division of Energy Market Oversight Division of Energy Market Oversight Division of Financial Market Assessment Division of Financial Market Assessment Division of Integrated Market Assessment Division of Integrated Market Assessment Division of Enforcement Division of Enforcement Division of Operational Investigations Division of Operational Investigations Division of Technical Investigations Division of Technical Investigations Market Scanning Market Scanning Division of Information Development Division of Information Development

5 Staff Report on Price Indices Reports on –Results of Commission’s two surveys –Adoption of Policy Statement standards by price reporting companies –Adherence to Policy Statement by price index publishers Outlines options for future action Recommends criteria for price indices used in jurisdictional tariffs Provides extensive technical appendix of tabulated survey results Commission to host conference June 25

6 Survey Results 189 responses from marketers, utilities, generators, LDCs, producers, and industrial consumers Of companies responding, 20% are reporting gas transactions and 10% are reporting electricity transactions, with producers doing the most reporting Natural gas indices are relied on more than electricity indices

7 Survey Results, continued Percent range of fixed-price transactions reported: –Day-ahead gas49-59% –Bid-week gas35-44% –Day-ahead electricity21-39% Confidence level a “7” on 1 to 10 scale—not a strong vote of confidence

8 Positive Impact of Policy Statement Reporting companies –Reporting from source independent of trading increased from 33% to 63% –Review by independent auditor increased from 5% to 58% –Adoption of public code of conduct increased from 36% to 65% –30 survey respondents report plans to begin or resume price reporting Price index developers –Most have code of conduct and uniform confidentiality agreements –Some provide indications of liquidity (tiers, daily volumes) –Most have improved verification process and have begun independent process reviews –However, developers were not sufficiently clear about FERC access to data for investigation of false reporting or manipulation

9 Options for the Future Accept current progress? Continue to focus attention? Introduce mandatory reporting? Increase reliance on platforms for trading, confirmation/settlement, and clearing?

10 Staff Recommendations For Index Use in Tariffs Approve six publishers, conditionally approve three more All approvals, however, subject to confirmation that Commission will have access to data for investigations All indices used in tariffs must provide volumes and number of transactions for each calculated index value by September 1, 2004 All index locations used in tariffs must meet minimum volume or transaction number criteria –25,000 MMBtu/d or 4000 MWh/d –5 trades (daily index), 8 trades (weekly index), or 10 trades (monthly index) Evaluate indices for historical period to determine if they meet volume and/or transaction number criteria

11 Conference at FERC June 25 Commission to get public input on: Overall market liquidity and adequacy of trading to generate reliable price signals Energy transaction reporting and adequacy and robustness of price indices Options for future action Observations on survey data (technical appendix) Staff recommendations for indices used in jurisdictional tariffs

12 New England Cold Snap: A Brief Recap What happened –Extreme cold led to record gas and electric demand –Gas and electric prices spiked upward January 14 and 15, declined Jan 16 –Gas-fired generators sold some firm gas into the spot market –ISO-NE asked for conservation and warned of potential rotating blackouts Investigation –Informal investigation initiated January 14 when gas prices spiked –Data requested from New England ISO, generators, LDCs, pipelines, and marketers –Follow-up interviews with selected participants Analysis seeking answers to: –Why was the system so stressed? –What caused spot gas prices to spike? –Why did generators sell gas rather than run? –Was the overall outcome reasonable? –Does something need to be fixed?

13 New England Hit By Extreme Cold Jan Record cold weather hit New England and Eastern Canada –16 to 24 degrees below normal –Significant wind LDCs experience record heating load –Northeast Gas Association issued a conservation notice January 15 ISO New England generation shortage –Conservation notices issued for Jan –Potential rotating blackout warning –OP4 reserve deficiency January 14

14 Pipelines Performed Close-to-Capacity During Intense Cold of January No pipeline service complaints –Critical notices and OFOs were enacted restricting flexibility and tolerances –Full contract demand served High capacity usage on Tennessee, Algonquin, Texas Eastern, Transco, Portland –Load factors ranged from 89 to 113 percent for January 14th and 15th. Lower utilization for Iroquois (73%) and Maritimes (75%) on January 14, 2004, the first day of the price spike. Low utilization is thought due to –Lack of supply on Maritimes –High demand in Eastern Canada –Northeast marketer exported gas to Eastern Canada to meet contract obligation Pipeline Utilization – January 14 Iroquois 73% Maritimes 75% Tennessee 111% Algonquin 99% Texas Eastern 92% Transco 94% PJM NY ISO ISO NE Portland 89%

15 Gas and Electricity Systems Worked Together Under Stress Both natural gas and electric markets performed under stress –Each market succeeded in making record deliveries and all firm customers received natural gas and power –Small quantities of natural gas traded at very high prices, which helped both markets meet the stress placed on them Natural gas and electric markets appear to have supported each other in meeting the demands made on both –Natural gas distribution companies used gas purchased from generators to meet critical peak heating load –Natural gas moved from generation to the heating market in response to price signals –Spot natural gas appears to have filled a crucial 5 percent of distribution company needs to supplement limited peak shaving inventories

16 ISO-NE Rules Coped with Stress ISO-NE’s rules allow generators to declare an outage for economic reasons, thus allowing generators to sell natural gas instead of using it for generation Sales of firm gas supply by generators alleviated severe conditions in the natural gas market Generators followed ISO-NE rules for notifying ISO- NE of economic outages and ISO-NE determined that enough other generation was available to meet projected needs Following unexpected mechanical outages due to severe cold, ISO-NE recalled enough generating capacity to make up for the reserve deficiency

17 Preliminary Conclusions Gas spot market functioned properly in rationing supply Power market cleared at a price lower than marginal cost of gas-fired generation Event revealed that infrastructure was pressed close to maximum limits Coordination between natural gas and electricity markets should be improved where possible

18 Natural gas market performance consistent with fundamental forces of supply, demand and seasonality Successes Products delivered on time Reasonable levels of investment Alternatives for managing risk Challenges Tight supplies –Severe storage volume swings –Deliverability constrained –Higher prices –Greater price volatility Thinly reported market activity –Credit problems –Decreasing volumes of trades –Index credibility erosion

19 High Prices Brings Extra Scrutiny The public is demanding explanations. A fallout of California and Enron is that explanations require detailed inquiries, not “faith in economics.” Knowledge can rebuild confidence. -price indices -event reports

20 OMOI Next Steps Continuous improvement -market surveillance reports -oversight meetings -seasonal look-aheads -definitions of market power, abuse, etc. Enhanced auditing -targeted -random Empowering key market participants -board members -engineers -others Rapid response to observed anomalies More intense scrutiny of less transparent markets Expanded teaming -MMUs -states -other federal agencies -North American colleagues