2010-10314

FR Doc 2010-10314[Federal Register: May 4, 2010 (Volume 75, Number 85)]

[Notices]

[Page 23729-23745]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr04my10-66]

[[Page 23729]]

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COMMODITY FUTURES TRADING COMMISSION

Orders Finding that the (1) Phys,\1\ BS,\2\ LD1 \3\ (US/MM), AB-

NIT;\4\ (2) Phys, BS, LD1 (US/MM), Union-Dawn; \5\ (3) Phys, FP,\6\

(CA/GJ),\7\ AB-NIT; (4) Phys, FP, (US/MM), Union-Dawn; and (5) Phys,

ID,\8\ 7a \9\ (CA/GJ), AB-NIT Contracts, Offered for Trading on the

Natural Gas Exchange, Inc., Do Not Perform a Significant Price

Discovery Function

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\1\ The acronym ``Phys'' indicates physical delivery of natural

gas.

\2\ The acronym ``BS'' indicates that the contract is a cash-

settled basis swap.

\3\ The acronym ``LD1'' indicates the final settlement price of

the New York Mercantile Exchange's (``NYMEX's'') physically-

delivered Henry Hub Natural Gas futures contract for the

corresponding contract month, which is expressed in U.S. dollars and

cents per million British thermal units (mmBtu).

\4\ The acronym ``AB-NIT'' refers to the Alberta, Canada, market

center and Nova Inventory Transfer hub.

\5\ ``Union-Dawn'' refers to the Union Gas, Ltd.'s, Dawn hub,

which is located in Canada across the U.S. border from Detroit,

Michigan.

\6\ The acronym ``FP'' refers to a fixed-price contract.

\7\ The abbreviation CA/GJ refers the Canadian dollars per

gigajoule, which is a unit of measure for energy. One GJ is equal to

0.9478 mmBtu.

\8\ The acronym ``ID'' refers to an index contract.

\9\ The term ``7a'' refers to a price index that is computed as

a volume-weighted average of transactions that occur on the Natural

Gas Exchange's trading platform during a particular calendar month.

Such transactions specify the physical delivery of natural gas at

the AB-NIT hub in the following calendar month.

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AGENCY: Commodity Futures Trading Commission.

ACTION: Final orders.

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SUMMARY: On October 20, 2009, the Commodity Futures Trading Commission

(``CFTC'' or ``Commission'') published for comment in the Federal

whether the (1) Phys, BS, LD1 (US/MM), AB-NIT (``Alberta Basis''); (2)

Phys, BS, LD1 (US/MM), Union-Dawn (``Union-Dawn Basis''); (3) Phys, FP,

(CA/GJ), AB-NIT (``Alberta Fixed-Price''); (4) Phys, FP, (US/MM),

Union-Dawn (``Union-Dawn Fixed-Price''); and (5) Phys, ID, 7a (CA/GJ),

AB-NIT (``7a Index'') contracts, which are listed for trading on the

Natural Gas Exchange, Inc. (``NGX''), an exempt commercial market

(``ECM'') under sections 2(h)(3)-(5) of the Commodity Exchange Act

(``CEA'' or the ``Act''), perform a significant price discovery

function pursuant to section 2(h)(7) of the CEA. The Commission

undertook this review based upon an initial evaluation of information

and data provided by NGX as well as other available information. The

Commission has reviewed the entire record in this matter, including all

comments received, and has determined to issue orders finding that the

Alberta Basis, Union-Dawn Basis, Alberta Fixed-Price, Union-Dawn Fixed-

Price and 7a Index contracts do not perform a significant price

discovery function. Authority for this action is found in section

2(h)(7) of the CEA and Commission rule 36.3(c) promulgated thereunder.

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\10\ 74 FR 53724 (October 20, 2009).

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DATES: Effective Date: April 28, 2010.

FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,

Division of Market Oversight, Commodity Futures Trading Commission,

Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

Telephone: (202) 418-5515. E-mail: [email protected]; or Susan Nathan,

Senior Special Counsel, Division of Market Oversight, same address.

Telephone: (202) 418-5133. E-mail: [email protected].

SUPPLEMENTARY INFORMATION:

I. Introduction

The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \11\

significantly broadened the CFTC's regulatory authority with respect to

ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory

category--ECMs on which significant price discovery contracts

(``SPDCs'') are traded--and treating ECMs in that category as

registered entities under the CEA.\12\ The legislation authorizes the

CFTC to designate an agreement, contract or transaction as a SPDC if

the Commission determines, under criteria established in section

2(h)(7), that it performs a significant price discovery function. When

the Commission makes such a determination, the ECM on which the SPDC is

traded must assume, with respect to that contract, all the

responsibilities and obligations of a registered entity under the Act

and Commission regulations, and must comply with nine core principles

established by new section 2(h)(7)(C).

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\11\ Incorporated as Title XIII of the Food, Conservation and

Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18,

2008).

\12\ 7 U.S.C. 1a(29).

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On March 16, 2009, the CFTC promulgated final rules implementing

the provisions of the Reauthorization Act.\13\ As relevant here, rule

36.3 imposes increased information reporting requirements on ECMs to

assist the Commission in making prompt assessments whether particular

ECM contracts may be SPDCs. In addition to filing quarterly reports of

its contracts, an ECM must notify the Commission promptly concerning

any contract traded in reliance on the exemption in section 2(h)(3) of

the CEA that averaged five trades per day or more over the most recent

calendar quarter, and for which the exchange sells its price

information regarding the contract to market participants or industry

publications, or whose daily closing or settlement prices on 95 percent

or more of the days in the most recent quarter were within 2.5 percent

of the contemporaneously determined closing, settlement or other daily

price of another contract.

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\13\ 74 FR 12178 (Mar. 23, 2009); these rules became effective

on April 22, 2009.

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Commission rule 36.3(c)(3) established the procedures by which the

Commission makes and announces its determination whether a particular

ECM contract serves a significant price discovery function. Under those

procedures, the Commission will publish notice in the Federal Register

that it intends to undertake an evaluation whether the specified

agreement, contract or transaction performs a significant price

discovery function and to receive written views, data and arguments

relevant to its determination from the ECM and other interested

persons. Upon the close of the comment period, the Commission will

consider, among other things, all relevant information regarding the

subject contract and issue an order announcing and explaining its

determination whether or not the contract is a SPDC. The issuance of an

affirmative order signals the effectiveness of the Commission's

regulatory authorities over an ECM with respect to a SPDC; at that time

such an ECM becomes subject to all provisions of the CEA applicable to

registered entities.\14\ The issuance of such an order also triggers

the obligations, requirements and timetables prescribed in Commission

rule 36.3(c)(4).\15\

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\14\ Public Law 110-246 at 13203; Joint Explanatory Statement of

the Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d

Sess. 978, 986 (Conference Committee Report). See also 73 FR 75888,

75894 (Dec. 12, 2008).

\15\ For an initial SPDC, ECMs have a grace period of 90

calendar days from the issuance of a SPDC determination order to

submit a written demonstration of compliance with the applicable

core principles. For subsequent SPDCs, ECMs have a grace period of

30 calendar days to demonstrate core principle compliance.

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II. Notice of Intent To Undertake SPDC Determination

On October 20, 2009, the Commission published in the Federal

Alberta Basis, Union-Dawn Basis, Alberta Fixed-

[[Page 23730]]

Price, Union-Dawn Fixed Price and 7a Index contracts perform a

significant price discovery function and requested comment from

interested parties.\16\ Comments were received from the Federal Energy

Regulatory Commission (``FERC''), NGX and Working Group of Commercial

Energy Firms (``WGCEF'').\17\ The comment letter from FERC \18\ did not

directly address the issue of whether or not the subject contracts are

SPDCs. NGX stated that the subject contracts lack sufficient liquidity

to perform a significant price discovery function. WGCEF argued that

the Alberta Basis and Union-Dawn Basis contracts fail to meet the

material price reference, price linkage and material liquidity criteria

for SPDC determination. Similarly, the 7a Index contracts lack

sufficient liquidity to perform a significant price discovery

function.\19\ NGX's and the Working Group's comments are more

extensively discussed below, as applicable.

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\16\ The Commission's Part 36 rules establish, among other

things, procedures by which the Commission makes and announces its

determination whether a specific ECM contract serves a significant

price discovery function. Under those procedures, the Commission

publishes a notice in the Federal Register that it intends to

undertake a determination whether a specified agreement, contract or

transaction performs a significant price discovery function and to

receive written data, views and arguments relevant to its

determination from the ECM and other interested persons.

\17\ FERC is an independent Federal regulatory agency that,

among other things, regulates the interstate transmission of natural

gas, oil and electricity. NGX is Canada's leading energy exchange

and North America's largest physical clearing and settlement

facility; NGX is wholly owned by the TMX Group, Inc. WGCEF describes

itself as ``a diverse group of commercial firms in the domestic

energy industry whose primary business activity is the physical

delivery of one or more energy commodities to customers, including

industrial, commercial and residential consumers'' and whose

membership consists of ``energy producers, marketers and

utilities.'' FIEG describes itself as an association of investment

and commercial banks who are active participants in various sectors

of the natural gas markets, ``including acting as marketers,

lenders, underwriters of debt and equity securities, and proprietary

investors.'' The comment letters are available on the Commission's

website: comment letters are available on the Commission's Web site:

http://www.cftc.gov/lawandregulation/federalregister/

federalregistercomments/2009/ 09-029.html.

\18\ FERC stated that the subject contracts call for physical

delivery of natural gas in Canada, and thus do not appear to be

interstate commerce under the Natural Gas Act (``NGA'').

Accordingly, FERC expressed the opinion that a determination by the

Commission that any of the contracts performs a significant price

discovery function ``would not appear to conflict with FERC's

exclusive jurisdiction under NGA over certain sales of natural gas

in interstate commerce for resale or with its other regulatory

responsibilities under the NGA'' and further that ``FERC staff will

continue to monitor for any such conflict * * * [and] advise the

CFTC'' should any such potential conflict arise. CL01.

\19\ WGCEF did not address whether the Alberta Fixed Price or

Union-Dawn Fixed Price contracts are SPDCs.

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III. Section 2(h)(7) of the CEA

The Commission is directed by section 2(h)(7) of the CEA to

consider the following criteria in determining a contract's significant

price discovery function:

Price Linkage--the extent to which the agreement, contract

or transaction uses or otherwise relies on a daily or final settlement

price, or other major price parameter, of a contract or contracts

listed for trading on or subject to the rules of a designated contract

market (``DCM'') or derivatives transaction execution facility

(``DTEF''), or a SPDC traded on an electronic trading facility, to

value a position, transfer or convert a position, cash or financially

settle a position, or close out a position.

Arbitrage--the extent to which the price for the

agreement, contract or transaction is sufficiently related to the price

of a contract or contracts listed for trading on or subject to the

rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of

an electronic trading facility, so as to permit market participants to

effectively arbitrage between the markets by simultaneously maintaining

positions or executing trades in the contracts on a frequent and

recurring basis.

Material price reference--the extent to which, on a

frequent and recurring basis, bids, offers or transactions in a

commodity are directly based on, or are determined by referencing or

consulting, the prices generated by agreements, contracts or

transactions being traded or executed on the electronic trading

facility.

Material liquidity--the extent to which the volume of

agreements, contracts or transactions in a commodity being traded on

the electronic trading facility is sufficient to have a material effect

on other agreements, contracts or transactions listed for trading on or

subject to the rules of a DCM, DTEF or electronic trading facility

operating in reliance on the exemption in section 2(h)(3).

Not all criteria must be present to support a determination that a

particular contract performs a significant price discovery function,

and one or more criteria may be inapplicable to a particular

contract.\20\ Moreover, the statutory language neither prioritizes the

criteria nor specifies the degree to which a SPDC must conform to the

various criteria. In Guidance issued in connection with the Part 36

rules governing ECMs with SPDCs, the Commission observed that these

criteria do not lend themselves to a mechanical checklist or formulaic

analysis. Accordingly, the Commission has indicated that in making its

determinations it will consider the circumstances under which the

presence of a particular criterion, or combination of criteria, would

be sufficient to support a SPDC determination.\21\ For example, for

contracts that are linked to other contracts or that may be arbitraged

with other contracts, the Commission will consider whether the price of

the potential SPDC moves in such harmony with the other contract that

the two markets essentially become interchangeable. This co-movement of

prices would be an indication that activity in the contract had reached

a level sufficient for the contract to perform a significant price

discovery function. In evaluating a contract's price discovery role as

a price reference, the Commission the extent to which, on a frequent

and recurring basis, bids, offers or transactions are directly based

on, or are determined by referencing, the prices established for the

contract.

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\20\ In its October 20, 2009, Federal Register release, the

Commission identified material price reference, price linkage and

material liquidity as the possible criteria for SPDC determination

of the Alberta Basis and Union-Dawn Basis contracts (arbitrage was

not identified as a possible criterion). With respect to the Alberta

Fixed-Price, Union-Dawn Fixed-Price and 7a Index contracts, the

Federal Register release identified material price reference and

material liquidity as the possible criteria for SPDC determination

(price linkage and arbitrage were not identified as possible

criteria). The criteria not indentified in the initial release will

not be discussed further in this document or the associated Orders.

\21\ 17 CFR part 36, Appendix A.

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IV. Findings and Conclusions

The Commission's findings and conclusions with respect to the

Alberta Basis, Union-Dawn Basis, Alberta Fixed-Price, Union-Dawn Fixed-

Price and 7a Index contracts are discussed separately below.

a. The Phys, BS, LD1 (US/MM), AB-NIT (Alberta Basis Contract) and the

SPDC Indicia

The Alberta Basis contract calls for the physical delivery of

natural gas based on the final settlement price for New York Mercantile

Exchange's (``NYMEX's'') Henry Hub physically-delivered Natural Gas

(``NG'') futures contract for the specified calendar month, plus or

minus the price differential (basis) between the Alberta delivery point

and the Henry Hub. There is no standard size for the Alberta Basis

contract, although a minimum

[[Page 23731]]

volume of 100 million British thermal units (``mmBtu'') is required in

increments of 100 units per day. The Alberta Basis contract is listed

for 60 consecutive calendar months.

The Henry Hub,\22\ which is located in Erath, Louisiana, is the

primary cash market trading and distribution center for natural gas in

the United States. It also is the delivery point and pricing basis for

the NYMEX's actively traded, physically-delivered natural gas futures

contract, which is the most important pricing reference for natural gas

in the United States. The Henry Hub, which is operated by Sabine Pipe

Line, LLC, serves as a juncture for 13 different pipelines. These

pipelines bring in natural gas from fields in the Gulf Coast region and

ship it to major consumption centers along the East Coast and Midwest.

The throughput shipping capacity of the Henry Hub is 1.8 trillion mmBtu

per day.

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\22\ The term ``hub'' refers to a juncture where two or more

natural gas pipelines are connected. Hubs also serve as pricing

points for natural gas at the particular locations.

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In addition to the Henry Hub, there are a number of other locations

where natural gas is traded. In 2008, there were 33 natural gas market

centers in North America.\23\ Some of the major trading centers include

Alberta, Northwest Rockies, Southern California border and the Houston

Ship Channel. For locations that are directly connected to the Henry

Hub by one or more pipelines and where there typically is adequate

shipping capacity, the price at the other locations usually directly

tracks the price at the Henry Hub, adjusted for transportation costs.

However, at other locations that are not directly connected to the

Henry Hub or where shipping capacity is limited, the prices at those

locations often diverge from the Henry Hub price. Furthermore, one

local price may be significantly different than the price at another

location even though the two markets' respective distances from the

Henry Hub are the same. The reason for such pricing disparities is that

a given location may experience supply and demand factors that are

specific to that region, such as differences in pipeline shipping

capacity, unusually high or low demand for heating or cooling or supply

disruptions caused by severe weather. As a consequence, local natural

gas prices can differ from the Henry Hub price by more than the cost of

shipping and such price differences can vary in an unpredictable

manner.

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\23\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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The Alberta hub is far removed from the Henry Hub and is not

directly connected to the Henry Hub by an existing pipeline. Located in

the Canadian province of Alberta, the Alberta natural gas market is a

major connection point for long-distance transmission systems that ship

natural gas to points throughout Canada and the United States. The

Alberta province is Canada's dominant natural gas producing region; six

of the nine Canadian market centers are located in the Alberta

province. The throughput capacity at the AECO-C hub is ten billion

cubic feet per day. Moreover, the number of pipeline interconnections

at that hub was four in 2008. Lastly, the AECO-C hub's capacity is 20.4

billion cubic feet per day.\24\

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\24\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf

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The local price at the Alberta hub typically differs from the price

at the Henry Hub. Thus, the price of the Henry Hub physically-delivered

futures contract is an imperfect proxy for the Alberta price. Moreover,

exogenous factors, such as adverse weather, can cause the Alberta gas

price to differ from the Henry Hub price by an amount that is more or

less than the cost of shipping, making the NYMEX Henry Hub futures

contract even less precise as a hedging tool than desired by market

participants. Basis contracts \25\ allow traders to more accurately

discover prices at alternative locations and hedge price risk that is

associated with natural gas at such locations. In this regard, a

position at a local price for an alternative location can be

established by adding the appropriate basis swap position to a position

taken in the NYMEX physically-delivered Henry Hub contract (or in the

NYMEX or ICE Henry Hub look-alike contract, which cash settle based on

the NYMEX physically-delivered NG contract's final settlement price).

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\25\ Basis contracts denote the difference in the price of

natural gas at a specified location minus the price of natural gas

at the Henry Hub. The differential can be either a positive or

negative value.

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In its October 20, 2009, Federal Register notice, the Commission

identified material price reference, price linkage and material

liquidity as the potential SPDC criteria applicable to the Alberta

Basis contract.\26\ Each of these criteria is discussed below.

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\26\ As noted above, the Commission did not find an indication

of arbitrage in connection with this contract; accordingly, that

criterion is not discussed in reference to the Alberta Basis

contract.

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1. Material Price Reference Criterion

The Commission's October 20, 2009, Federal Register notice

identified material price reference as a potential basis for a SPDC

determination with respect to the Alberta Basis contract. The

Commission noted that NGX forged an alliance with the

IntercontinentalExchange, Inc., (``ICE'') to use the ICE's matching

engine to complete transactions in physical natural gas contracts

traded on NGX. In return, NGX agreed to provide clearing services for

such transactions. As part of the agreement, NGX provides ICE with

transaction data, which are then made available to market participants

on a paid basis. ICE offers NGX's price data in several packages, which

vary in terms of the amount of available historical data. For example,

the ICE offers the ``OTC Gas End of Day'' data package with access to

all price data, or just current prices plus a selected number of months

(i.e., 12, 24, 36, or 48 months) of historical data.

The Commission will rely on one of two sources of evidence--direct

or indirect--to determine that the price of a contract was being used

as a material price reference and therefore, serving a significant

price discovery function.\27\ With respect to direct evidence, the

Commission will consider the extent to which, on a frequent and

recurring basis, cash market bids, offers or transactions are directly

based on or quoted at a differential to, the prices generated on the

ECM in question. Direct evidence may be established when cash market

participants are quoting bid or offer prices or entering into

transactions at prices that are set either explicitly or implicitly at

a differential to prices established for the contract in question. Cash

market prices are set explicitly at a differential to the section

2(h)(3) contract when, for instance, they are quoted in dollars and

cents above or below the reference contract's price. Cash market prices

are set implicitly at a differential to a section 2(h)(3) contract

when, for instance, they are arrived at after adding to, or subtracting

from the section 2(h)(3) contract, but then quoted or reported at a

flat price. With respect to indirect evidence, the Commission will

consider the extent to which the price of the contract in question is

being routinely disseminated in widely distributed industry

publications--or offered by the ECM itself for some form of

remuneration--and consulted on a frequent and recurring basis by

industry

[[Page 23732]]

participants in pricing cash market transactions.

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\27\ 17 CFR part 36, Appendix A.

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The Alberta hub is a major trading center for natural gas in North

America. Traders, including producers, keep abreast of the prices of

the Alberta market center when conducting cash deals. However, ICE's

cash-settled AECO Financial Basis contract is used more widely as a

price reference than the NGX Alberta Basis contract. Traders look to

ICE contract's competitively determined price as an indication of

expected values of natural gas at the Alberta hub when entering into

cash market transactions for natural gas, especially those trades

providing for physical delivery in the future. Moreover, traders use

ICE's AECO Financial Basis contract, as well as other basis contracts,

to hedge cash market positions and transactions. The substantial volume

of trading and open interest in the ICE contract attests to its use for

this purpose.\28\ In contrast, trading volume in the NGX Alberta Basis

contract is much smaller than in ICE's cash-settled version of the

contract. In this regard, total trading volume in the NGX Alberta Basis

contract in the third quarter of 2009 was equivalent to 52,158 NYMEX

physically-delivered natural gas contracts, which has a size of 10,000

mmBtu.

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\28\ In the third quarter of 2009, 6,320 separate trades

occurred on ICE's electronic platform in its AECO Financial Basis

contract, resulting in a daily average of 95.8 trades. During the

same period, the ICE contract had a total trading volume on its

electronic platform of 736,412 contracts (which was an average of

11,158 contracts per day). As of September 30, 2009, open interest

in the ICE AECO Financial Basis contract was 483,561 contracts.

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Accordingly, although the Alberta Hub is a major trading center for

natural gas and, as noted, NGX provides price information for the

Alberta Basis contract to ICE which sells it, the Commission has found

upon further evaluation that the Alberta Basis contract is not

routinely consulted by industry participants in pricing cash market

transactions and thus does not meet the Commission's Guidance for the

material price reference criterion. In this regard, the ICE AECO

natural gas futures contract is routinely consulted by industry

participants in pricing cash market transactions at this location.

Because both the NGX and the ICE contracts basically price the same

commodity at the same location and time and the ICE contract has

significantly higher trading volume and open interest, it is not

necessary for market participants to independently refer to the NGX

Alberta Basis contract for pricing natural gas at this location. Thus,

the Alberta Basis contract does not satisfy the direct price reference

test for existence of material price reference. Furthermore, the

Commission notes that publication of the Alberta Basis contract's

prices is not indirect evidence of material price reference. The

Alberta Basis contract's prices are published with those of numerous

other contracts, including ICE's AECO Financial Basis contract, which

are of more interest to market participants. Thus, the Commission has

concluded that traders likely do not specifically purchase ICE data

packages for the NGX Alberta Basis contract's prices and do not consult

such prices on a frequent and recurring basis in pricing cash market

transactions.

i. Federal Register Comments

NGX states its opinion that the Alberta Basis contract does not

satisfy the material price reference criteria because the contract

lacks sufficient liquidity, and ``the consideration of liquidity is

implicitly understood to be a relevant, if not fundamental factor,

where material price reference is being considered.'' \29\ Furthermore,

NGX opined that the Commission purported ``to adopt a threshold as low

as 5, 10 or 20 trades per day as sufficiently material to attract a

SPDC designation.'' \30\ In this regard, the Commission adopted a five

trades-per-day threshold as a reporting requirement to enable it to

``independently be aware of ECM contracts that may develop into SPDCs''

\31\ rather than solely relying upon an ECM on its own to identify any

such potential SPDCs to the Commission. Thus, any contract that meets

this threshold may be subject to scrutiny as a potential SPDC. However,

this does not mean that the contract will be found to be a SPDC merely

because it met the reporting threshold. WGCEF states that there is no

direct evidence that any contracts on any market settle to or reference

the NGX Alberta Basis price. Moreover, WGCEF ``does not believe the

fact that ICE publishes the settlement prices of NGX physical

transactions constitutes sufficient evidence of a Material Price

Reference necessary to satisfy the requirements of CEA Section

2(h)(7)(B)(iii).'' It notes that the publication of NGX price data by

ICE is the result of a unique arrangement between ICE and NGX, whereby

ICE serves as the exclusive trading platform for NGX contracts and NGX

does not publish any trade data on its own website. ``Given this unique

arrangement,'' WGCEF asserts, ``it is only logical that ICE publishes

transaction data regarding the NGX physical deals in its ``OTC Gas End

of Day'' publication.'' As noted above, the Commission believes that

publication of the Alberta Basis contract's prices is not indirect

evidence of material price reference. The Alberta Basis contract's

prices are published with those of numerous other contracts, including

ICE's AECO Financial Basis contract, which are of more interest to

market participants. As a result, the Commission has concluded that

traders likely do not specifically purchase ICE data packages for the

NGX Alberta Basis contract's prices and do not consult such prices on a

frequent and recurring basis in pricing cash market transactions.

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\29\ CL 02.

\30\ Id.

\31\ 73 FR 75892 (December 12, 2008)

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ii. Conclusion Regarding Material Price Reference

Based on the above, the Commission finds that the NGX Alberta Basis

contract does not meet the material price reference criterion because

cash market transactions are not priced either explicitly or implicitly

on a frequent and recurring basis at a differential to the Alberta

Basis contract's price (direct evidence). Moreover, while the Alberta

Basis contract's price data is sold to market participants, market

participants likely do not specifically purchase the ICE data packages

for the Alberta contract's prices and do not consult such prices on a

frequent and recurring basis in pricing cash market transactions

(indirect evidence).

2. Price Linkage Criterion

In its October 20, 2009, Federal Register notice, the Commission

identified price linkage as a potential basis for a SPDC determination

with respect to the Alberta Basis contract. In this regard, the final

settlement of the Alberta Basis contract is based, in part, on the

final settlement price of NYMEX's Henry Hub physically delivered NG

futures contract, where NYMEX is registered with the Commission as a

DCM.

The Commission's Guidance on Significant Price Discovery Contracts

notes that a ``price-linked contract is a contract that relies on a

contract traded on another trading facility to settle, value or

otherwise offset the price-linked contract.'' \32\ Furthermore, the

Guidance notes that ``[f]or a linked contract, the mere fact that a

contract is linked to another contract will not be sufficient to

support a determination that a contract performs a significant

[[Page 23733]]

price discovery function. To assess whether such a determination is

warranted, the Commission will examine the relationship between

transaction prices of the linked contract and the prices of the

referenced contract. The Commission believes that where material

liquidity exists, prices for the linked contract would be observed to

be substantially the same as, or move substantially in conjunction

with, the prices of the referenced contract.'' The Guidance proposes a

threshold price relationship such that prices of the ECM linked

contract will fall within a 2.5 percent price range for 95 percent of

contemporaneously determined closing, settlement or other daily prices

over the most recent quarter. Finally, the Commission also stated in

the Guidance that it would consider a linked contract that has a

trading volume equivalent to 5 percent of the volume of trading in the

contract to which it is linked to have sufficient volume potentially to

be deemed SPDC (``minimum threshold'').

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\32\ Appendix A to the Part 36 rules.

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To assess whether the Alberta Basis contract meets the price

linkage criterion, Commission staff obtained price data from NGX and

performed the statistical tests cited above. Staff found that, while

the Alberta Basis contract price is determined, in part, by the final

settlement price of the NYMEX physically delivered natural gas futures

contract (a DCM contract), the imputed Alberta price (derived by adding

the NYMEX Henry Hub Natural Gas price to the Alberta Basis price) is

not within 2.5 percent of the settlement price of the corresponding

NYMEX Henry Hub natural gas futures contract on 95 percent or more of

the days. Specifically, during the third quarter of 2009, none of the

Alberta Basis natural gas prices derived from the NGX basis values were

within 2.5 percent of the daily settlement price of the NYMEX Henry Hub

futures contract. In addition, staff found that the Alberta Basis

contract fails to meet the volume threshold requirement. In particular,

the total trading volume in the NYMEX NG contract during the third

quarter of 2009 was 14,022,963 contracts, with 5 percent of that number

being 701,148 contracts. Trades on the NGX centralized market in the

Alberta Basis contract during the same period was 52,168 NYMEX-

equivalent contracts. Thus, centralized-market trades in the Alberta

Basis contract amounted to less than the minimum threshold.

i. Federal Register Comments

NGX states its belief that the Alberta Basis contract does not meet

the price linkage factor because there is insufficient trading activity

in this contract.

WGCEF acknowledges that the Alberta Basis contract is technically

linked to the NYMEX Henry Hub NG contract. However, WGCEF contends that

a comparison of the Alberta Basis contract price with NYMEX NG

settlement prices from July 21, 2009 through November 2, 2009 clearly

establishes that prices for these contracts are not substantially the

same and do not move substantially in conjunction with one another.

ii. Conclusion Regarding the Price Linkage Criterion

The Commission finds that the NGX Alberta Basis contract does not

meet the price linkage criterion because it fails the price

relationship and volume test provided for in the Commission's Guidance.

3. Material Liquidity Criterion

As noted above, in its October 20, 2009, Federal Register notice,

the Commission identified material liquidity, price linkage and

material price reference as potential criteria for SPDC determination

of the AB contract. To assess whether a contract meets the material

liquidity criterion, the Commission first examines trading activity as

a general measurement of the contract's size and potential importance.

If the Commission finds that the contract in question meets a threshold

of trading activity that would render it of potential importance, the

Commission will then perform a statistical analysis to measure the

effect that changes to the subject-contract's prices potentially may

have on prices for other contracts listed on an ECM or a DCM.

With respect to the material liquidity criterion, the Commission

noted that the average number of transactions in the Alberta Basis

nearby month contract was 23.2 trades per day in the second quarter of

2009. During the same period, the Alberta Basis contract had an average

daily trading volume of 5,869,000 mmBtu (or 587 NYMEX-equivalent

contracts of 10,000 mmBtu size). Moreover, open interest as of June 30,

2009, was 150,213,600 mmBtu in the nearby month (15,021 NYMEX

equivalents) and 10,112,200 mmBtu (1,011 NYMEX equivalents) for

delivery two months out.\33\

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\33\ Second quarter 2009 data was submitted to the Commission in

a different format than in later filings. In this regard total

trading volume and total number of trades per quarter were not

identified.

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In a subsequent filing, NGX reported that in the third quarter of

2009 the total number of transactions was 2,640 trades (an average of

40 trades per day). Trading volume in the third quarter of 2009 was

521,580,000 mmBtu (52,158 NYMEX-equivalent contracts) or an average of

7,900,000 mmBtu (790 NYMEX-equivalent contracts) on a daily basis. As

of September 30, 2009, open interest in the Alberta Basis contract was

6,440,000 mmBtu (644 NYMEX-equivalent contracts).

The number of trades per day remained relatively low from the

second to third quarters of 2009, and averaged only slightly more than

the reporting level of five trades per day. Moreover, trading activity

in the Alberta Basis contract, as characterized by total quarterly

volume, indicates that the Alberta Basis contract experiences trading

activity that is similar to that of minor futures markets.\34\ Thus,

the Alberta Basis contract does not meet a threshold of trading

activity that would render it of potential importance and no additional

statistical analysis is warranted.\35\

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\34\ Based on the Commission's experience, a minor futures

contract is, generally, one that has a quarterly trading volume of

100,000 contracts or less.

\35\ In establishing guidance to illustrate how it will evaluate

the various criteria, or combinations of criteria, when determining

whether a contract is an SPDC, the Commission made clear that

``material liquidity itself would not be sufficient to make a

determination that a contract is a [SPDC], * * * but combined with

other factors it can serve as a guidepost indicating which contracts

are functioning as [SPDCs].'' For the reasons discussed above, the

Commission has found that the Union-Dawn Basis contract does not

meet either the price linkage or material price reference criterion.

In light of this finding and the Commission's Guidance cited above,

there is no need to evaluate further the material liquidity criteria

since it cannot be used alone as a basis for an SPDC determination.

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i. Federal Register Comments

NGX stated in its comment letter that the Alberta Basis contract

does not meet the material liquidity criterion for SPDC determination

for a number of reasons.

First, NGX opined that the Commission ``seems to have applied a

threshold for `material liquidity' that is extremely low, and in

general insufficient to support a determination that these contracts

are no longer emerging markets but in fact serve a significant price

discovery function.'' NGX also noted that the Commission's Guidance

states that material liquidity was intended to be a ``broad concept

that captures the ability to transact immediately with little or no

price concession.'' The Guidance also states that where ``material

liquidity exists, a more or less continuous stream of prices can be

observed and the prices should be similar,'' such as ``where trades

occur multiple times per minute.'' NGX then opined that ``[t]he levels

of liquidity

[[Page 23734]]

outlined above for the Proposed Contracts cannot be what Congress

intended in establishing the dividing line between contracts ripe for

regulation and those still emerging and in need of further

incubation.''

WGCEF used arguments similar to those of NGX in opining that the

Alberta Basis contract does not meet the material liquidity criterion.

For example, WGCEF stated that the Alberta Basis contract does not have

an effect on other contracts that are listed for trading, particularly

the NYMEX NG contract. WGCEF pointed out the Commission's Guidance

which states that a ``continuous stream of prices'' should be observed

in markets with material liquidity. In addition, WGCEF indicated that

in liquid markets observed prices should be similar to each other and

that transactions should occur multiple times per minute; ``the trade

frequency of the Alberta Basis Contract in terms of multiple trades per

minute is very low.'' In this regard, the Commission notes that it

adopted a five trades-per-day threshold as a reporting requirement to

enable it to ``independently be aware of ECM contracts that may develop

into SPDCs'' \36\ rather than solely relying upon an ECM on its own to

identify any such potential SPDCs to the Commission. Thus, any contract

that meets this threshold may be subject to scrutiny as a potential

SPDC but this does not mean that the contract will be found to be a

SPDC merely because it met the reporting threshold. Furthermore, the

Commission observes that a continuous stream of prices would indeed be

an indication of liquidity for certain markets but the Guidance also

notes that ``quantifying the levels of immediacy and price concession

that would define material liquidity may differ from one market or

commodity to another.''

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\36\ 73 FR 75892 (December 12, 2008).

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ii. Conclusion Regarding Material Liquidity

For the reasons discussed above, the Commission finds that the

Alberta Basis contract does not meet the material liquidity criterion.

4. Overall Conclusion Regarding the Alberta Basis Contract

After considering the entire record in this matter, including the

comments received, the Commission has determined that the NGX Alberta

Basis contract does not perform a significant price discovery function

under the criteria established in section 2(h)(7) of the CEA.

Specifically, the Commission has determined that the NGX Alberta Basis

contract does not meet the material price reference, price linkage, or

material liquidity criteria at this time. Accordingly, the Commission

is issuing the attached Order declaring that the Alberta Basis contract

is not a SPDC.

Issuance of this Order indicates that the Commission does not at

this time regard NGX as a registered entity in connection with its

Alberta Basis contract.\37\ Accordingly, with respect to its Alberta

Basis contract, NGX is not required to comply with the obligations,

requirements and timetables prescribed in Commission rule 36.3(c)(4)

for ECMs with SPDCs. However, NGX must continue to comply with the

applicable reporting requirements for ECMs.

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\37\ See 73 FR 75888, 75893 (Dec. 12, 2008).

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b. The Phys, BS, LD1 (US/MM), Union-Dawn (Union-Dawn Basis) Contract

and the SPDC Indicia

The NGX Union-Dawn Basis contract is a monthly contract that calls

for physical delivery of natural gas based on the final settlement

price for NYMEX's Henry Hub physically-delivered natural gas futures

contract for the specified calendar month, plus or minus the price

differential (basis) between the Dawn delivery point and the Henry Hub.

There is no standard size for the Union-Dawn Basis contract, although a

minimum volume of 100 mmBtu is required in increments of 100 units per

day. The Union-Dawn Basis contract is listed for 60 consecutive

calendar months.

The Henry Hub,\38\ which is located in Erath, Louisiana, is the