Add a bookmark to get started

Website_Hero_Abstract_Architectural_Shapes_P_0031
13 June 20217 minute read

A long hot summer: Five steps for energy commodities traders in a time of heightened scrutiny

Regulatory intervention tends to increase in times of crisis or uncommon market conditions. In 2020, for instance, while markets operated under the effects of the coronavirus, the Commodity Futures Trading Commission (CFTC) experienced a record enforcement year – filing 113 enforcement actions, the highest in its history, and collecting over $1.3 billion in monetary relief, the fourth highest sum in its history. After hurricanes, the Federal Energy Regulatory Commission (FERC) has approved temporary waivers to allow natural resource providers the ability to restore service and deliver product to the market. During Winter Storm Uri, the Electric Reliability Council of Texas (ERCOT), at the direction of the Public Utilities Commission of Texas (PUCT), increased the cost of electricity to $9,000MW/hr for nearly 32 hours to address market scarcity.

It is also true that when acute market conditions arise, regulators keep an eye out for those attempting to take advantage of the crisis.  One significant example is that of the Western energy crisis of 2000 – 2001; ultimately, FERC discovered that the Enron Corporation had deliberately created real and imaginary shortages of electricity in the US with the aim of raising prices.  We can also point to the regulatory responses to the waves of fraud that arose in the wake of such natural disasters as Hurricane Sandy and Hurricane Katrina.  In short, regulatory intervention and scrutiny increase during times of acute market conditions. 

Right now, in June 2021, the commodities markets are already volatile.  Prices are rising as the national economy starts recovering from the COVID-19 pandemic; on June 10, it was widely reported that food and energy cost 5 percent more now than one year ago and that the Consumer Price Index is at a 13-year high.   Furthermore, studies are being conducted to determine how energy pricing, especially in ERCOT, may be restructured. All of this suggests that regulatory intervention may well be heightened throughout the season.

To possibly add to the market volatility, it is not out of the question that the summer of 2021 may see unusually high temperatures across large swathes of the country. While the Farmer’s Almanac predicted that June temperatures in the Texas/Oklahoma area would be one degree cooler than normal, ERCOT and the National Oceanic and Atmospheric Administration disagreed. Furthermore, much of the West remains in extreme drought. Weather extremes create conditions of rapidly changing supply-and-demand fundamentals that affect the energy commodity markets – as temperatures rise, the demand for power increases, and to meet this demand, many power plants fueled by natural gas must buy increasing amounts of natural gas, which in turn may create an increased volume of trading in natural gas futures contracts. In other words, higher temperatures could create volatility in electricity and natural gas markets, two markets that have shown themselves to be sensitive to weather conditions.

Accordingly, energy commodity trading companies are encouraged to pay close attention to their trading activities and observe the following five steps in order to mitigate the risk of heightened scrutiny from, and to ensure compliance with the latest regulations and policies of, the CFTC, FERC, and other state level regulatory agencies.

1. Compliance manuals: Redistribute

Particularly in times of heightened scrutiny, it is paramount to remember the rules and regulations applicable to front-office personnel in energy commodity marketing and trading .

Often in times of extreme weather events, there are large price fluctuations in the energy market, which could bring opportunities to make unusually large profits. To reduce the possibility of front-office personnel engaging in impermissible activity or appearing as if they are engaging in impermissible activity, energy commodity marketing and trading companies may redistribute their regulatory compliance manuals, accompanied by a cover letter from the legal and/or compliance department, outlining the need to trade with heightened sensitivity to regulation and common sense.

Updating the front-office attestations of reading, understanding and agreeing to abide by the rules, regulations and policies outlined in the compliance manuals is also a good practice, especially in times of increased scrutiny.

2. Legal and compliance personnel: Reminder to consult with legal and/or compliance personnel

Particularly in times of heightened scrutiny, legal and/or compliance departments may wish to remind front-office personnel to be wary of transactions that seem too good to be true. Some profits may well be legitimate but could be seen, in hindsight, as taking advantage of the crisis situation or acute market conditions.

For these reasons, companies may make legal and compliance personnel available for questions and consultation during these times. Since many energy commodity marketing and trading firms do have legal and compliance personnel on hand for questions, during times of crisis or acute market conditions, companies may choose to remind front-office personnel to consult with them prior to entering into transactions that either: (a) deviate (in volume, price, commodity, location) from the usual transactions entered into by such front-office personnel or (b) are generating unusually high profits for the type of transaction.

Management may also decide to set a clear trading strategy for front-office personnel as well as standards for compliance with such strategy; any deviations would require approvals from management, the legal department, and/or the compliance department, as appropriate.

3.  Compliance training: Conduct additional targeted training on market manipulation, fraud, disruptive trade practices

Times of heightened scrutiny afford an opportunity for targeted training of all employees (including front-, mid-, and back-office personnel) regarding market manipulation, fraud and disruptive trade. In addition to the redistribution of the compliance manuals, targeted training may help to prevent inadvertent regulatory violations and/or the appearance of regulatory violations.

It may also be prudent to put all personnel on alert for possible regulatory violations and/or the appearance of regulatory violations. For example, the settlements department may be asked by a counterparty to change a price on a transaction prior to finalizing the settlement payment. The justification for such a request could be higher regulatory scrutiny. However, this could also present as a red flag, because, heightened scrutiny or not, the pricing of a transaction is generally agreed to at the time of the transaction’s execution by front-office personnel.

4.  Trade surveillance: Reviewing standard deviations in volume and prices

Redistributing compliance manuals and targeted training is helpful to prevent regulatory infractions and/or the appearance of regulatory infractions during times of crisis, while trade surveillance actively monitors activities to identify infractions.

Particularly in times of heightened scrutiny, trade surveillance is expected to look for indicia of infractions, such as unusually large standard deviations in (a) the volume of trading per individual front-office person, per trading book and per product as compared to previously traded volumes and (b) the prices of transactions as compared to prevailing market prices.

5.  Remote logins: Ensure proper risk control functionality for remote marketing and trading activities

It is also possible that, during a crisis, front-office personnel may be required to trade remotely from home and/or disaster recovery centers. Companies are encouraged to ensure that risk control functionality, such as monitoring value at risk and conducting marked-to-market calculations on these transactions, continue even though front-office personnel are trading remotely.

Value-at-risk and marked-to-market calculations are helpful tools to ensure that front=office personnel are maintaining appropriate positions and at appropriate prices for the current market.  Before a crisis strikes, companies are encouraged to test risk control functionality to help ensure that the remote transaction data can be properly aggregated to carry out these calculations. 

Conclusion

Energy commodity marketing and trading companies are encouraged to prepare to continue to operate this summer under increased regulatory scrutiny. If the proper plans are in place, commodity marketing and trading companies may mitigate or prevent issues that could prompt a regulatory inquiry and/or regulatory investigation.

Energy commodity markets and regulatory oversight of such markets is dynamic, and the above guidelines are subject to change. For more information and/or if there are any questions, please contact either of the authors. 

Print