2010-17747

FR Doc 2010-17747[Federal Register: July 21, 2010 (Volume 75, Number 139)]

[Notices]

[Page 42380-42390]

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

[DOCID:fr21jy10-38]

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COMMODITY FUTURES TRADING COMMISSION

Orders Finding That the SP-15 Financial Day-Ahead LMP Peak

Contract and SP-15 Financial Day-Ahead LMP Off-Peak Contract Offered

for Trading on the IntercontinentalExchange, Inc., Perform a

Significant Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final orders.

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SUMMARY: On October 6, 2009, the Commodity Futures Trading Commission

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

[[Page 42381]]

undertake a determination whether the SP-15 \2\ Financial Day-Ahead LMP

Peak (``SPM'') contract and SP-15 Financial Day-Ahead LMP Off-Peak

(``OFP'') contract,\3\ which are listed for trading on the

IntercontinentalExchange, Inc. (``ICE''), 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 ICE 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

SPM and OFP contracts 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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\1\ 74 FR 51264 (October 6, 2009).

\2\ The acronym ``SP'' stands for ``South Path.''

\3\ The Federal Register notice also requested comment on the

SP-15 Financial Day-Ahead LMP Peak Daily (``SDP'') contract; SP-15

Financial Day-Ahead LMP Off-Peak Daily (``SQP'') contract; SP-15

Financial Swap Real Time LMP-Peak Daily (``SRP'') contract; NP-15

Financial Day-Ahead LMP Peak Daily (``DPN'') contract and NP-15

Financial Day-Ahead LMP Off-Peak Daily (``UNP'') contract; these

contracts will be addressed in a separate Federal Register release.

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DATES: Effective Date: July 9, 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'') \4\

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.\5\ 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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\4\ Incorporated as Title XIII of the Food, Conservation and

Energy Act of 2008, Public Law No. 110-246, 122 Stat. 1624 (June 18,

2008).

\5\ 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.\6\ 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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\6\ 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.\7\ The issuance of such an order also triggers the

obligations, requirements and timetables prescribed in Commission rule

36.3(c)(4).\8\

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\7\ 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).

\8\ 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 6, 2009, the Commission published in the Federal

SPM and OFP contracts \9\ perform a significant price discovery

function and requested comment from interested parties.\10\ Comments

were received from the Federal Energy Regulatory Commission (``FERC''),

Electric Power Supply Association (``EPSA''), Financial Institutions

Energy Group (``FIEG''), Working Group of Commercial Energy Firms

(``WGCEF''), ICE, California Public Utilities Commission (``CPUC''),

Edison Electric Institute (``EEI''), Western Power Trading Forum

(``WPTF'') and Public Utility Commission of Texas (``PUCT'').\11\ The

comment letters from

[[Page 42382]]

FERC \12\ and PUCT did not directly address the issue of whether or not

the subject contracts are SPDCs. CPUC stated that the subject contracts

are SPDCs but did not provide reasons for how the contracts meet the

criteria for SPDC determination. The remaining comment letters raised

substantive issues with respect to the applicability of section 2(h)(7)

to the subject contracts and generally expressed the opinion that the

contracts are not SPDCs because they do not meet the material price

reference or material liquidity criteria for SPDC determination. These

comments are more extensively discussed below, as applicable.

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\9\ As noted above, the Federal Register notice also requested

comment on the SP-15 Financial Day-Ahead LMP Peak Daily (``SDP'')

contract; SP-15 Financial Day-Ahead LMP Off-Peak Daily (``SQP'')

contract; SP-15 Financial Swap Real Time LMP-Peak Daily (``SRP'')

contract; NP-15 Financial Day-Ahead LMP Peak Daily (``DPN'')

contract and NP-15 Financial Day-Ahead LMP Off-Peak Daily (``UNP'')

contract. These contracts will be addressed in a separate Federal

\10\ 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.

\11\ FERC is an independent federal regulatory agency that,

among other things, regulates the interstate transmission of natural

gas, oil and electricity. EPSA describes itself as the ``national

trade association representing competitive power suppliers,

including generators and marketers.'' 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.'' 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.'' ICE is an ECM, as noted above. CPUC is a

``constitutionally established agency charged with the

responsibility for regulating electric corporations within the State

of California.'' EEI is the ``association of shareholder-owned

electric companies, international affiliates and industry associates

worldwide.'' WPTF describes itself as a ``broad-based membership

organization dedicated to encouraging competition in the Western

power markets * * * WTPF strives to reduce the long-run cost of

electricity to consumers throughout the region while maintaining the

current high level of system reliability.'' PUCT is the independent

organization that oversees the Electric Reliability Council of Texas

(``ERCOT'') to ``ensure nondiscriminatory access to the transmission

and distribution systems, to ensure the reliability and adequacy of

the regional electrical network, and to perform other essential

market functions.'' The comment letters are available on the

Commission's Web site: http://www.cftc.gov/lawandregulation/

federalregister/federalregistercomments/2009/09-012.html.

\12\ FERC expressed the opinion that a determination by the

Commission that either of the subject contracts performs a

significant price discovery function ``would not appear to conflict

with FERC's exclusive jurisdiction under the Federal Power Act (FPA)

over the transmission or sale for resale of electric energy in

interstate commerce or with its other regulatory responsibilities

under the FPA'' and further that ``FERC staff will monitor proposed

SPDC determinations and advise the CFTC of any potential conflicts

with FERC's exclusive jurisdiction over RTOs, [(regional

transmission organizations)], ISOs [(independent system operators)]

or other jurisdictional entities.''

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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.\13\ 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.\14\ 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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\13\ In its October 6, 2009, Federal Register release, the

Commission identified material price reference and material

liquidity as the possible criteria for SPDC determination of the SPM

and OFP contracts. Arbitrage and price linkage were not identified

as possible criteria. As a result, arbitrage and price linkage will

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

\14\ 17 CFR 36, Appendix A.

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IV. Findings and Conclusions

The Commission's findings and conclusions with respect to the SPM

and OFP contracts are discussed separately below.

a. The SP-15 Financial Day-Ahead LMP Peak (SPM) Contract and the SPDC

Indicia

The SPM contract is cash settled based on the arithmetic average of

peak-hour, day-ahead locational marginal prices (``LMPs'') \15\ posted

by the California ISO \16\ (``CAISO'') for the SP-15 Existing Zone

Generation (``EZ Gen'') hub for all peak hours during the contract

month. The LMPs are derived from power trades that result in physical

delivery. The size of the SPM contract is 400 megawatt hours (``MWh''),

and the SPM contract is listed for up to 110 calendar months.

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\15\ An LMP represents the additional cost associated with

producing an incremental amount of electricity. LMPs account for

generation costs, congestion along the transmission lines, and

electricity loss.

\16\ The acronym ``ISO'' signifies ``Independent System

Operator,'' which is an entity that coordinates electricity

generation and transmission, as well as grid reliability, throughout

its service area.

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In general, electricity is bought and sold in an auction setting on

an hourly basis at various point along the electrical grid. An LMP

associated with a specific hour is derived as a volume-weighted average

price of all of the transactions where electricity is to be supplied

and consumed during that hour.

Electricity is traded in a day-ahead market as well as a real-time

market. Typically, the bulk of energy transactions occur in the day-

ahead market. The day-ahead market establishes prices for electricity

that is to be delivered during the specified hour on the following day.

Day-ahead prices are determined based on generation and energy

transaction

[[Page 42383]]

quotes offered in advance. Because the power quotes are dependent on

estimates of supply and demand, electricity needs usually are not

perfectly satisfied in the day-ahead market. In this regard, on the day

the electricity is transmitted and used, auction participants typically

realize that they bought or sold either too much power or too little

power. A real-time auction is operated to alleviate this problem by

serving as a balancing mechanism. Specifically, electricity traders use

the real-time market to sell excess electricity and buy additional

power to meet demand. Only a relatively small amount of electricity is

traded in the real-time market as compared to the day-ahead market.

Path 15 is an 84-mile portion of the north-south power transmission

corridor in California, forming part of the Pacific AC Intertie and the

California-Oregon Transmission Project.\17\ Path 15, along with the

Pacific DC Intertie running far to the east, completes an important

transmission interconnection between the hydroelectric plants to the

north and the fossil fuel plants to the south. Path 15 currently

consists of three lines at 500 kilovolts (``kV'') and four lines at 230

kV.\18\ The 500 kV lines connect Los Banos to Gates (two lines) and Los

Banos to Midway (one line); all four 230 kV lines have Gates at one end

with the other ends terminating at the Panoche 1, Panoche

2, Gregg, or McCall substations. ``NP-15'' refers to the

northern half of Path 15; conversely, ``SP-15'' refers to the lower

half of Path 15.

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\17\ The Pacific Intertie comprises three alternating current

(``AC'') lines and one direct current (``DC'') line. Together, these

lines comprise the largest single electricity transmission program

in the United States. The northern end of the DC line is at the

Bonneville Power Administration's Celilo Converter Station, which is

just south of The Dalles Dam about 90 miles east of Portland. The

southern end is 846 miles away at the Sylmar Converter Station on

the northern outskirts of Los Angeles. That station is operated by

utilities including the Los Angeles Department of Water and Power

(``LADWP'') and Southern California Edison. The AC lines follow

generally the same path but terminate in Northern California. Only a

few parties actually own the Intertie, but numerous entities have

contracts to share its transmission capacity. The California-

California border is a dividing line for Intertie ownership and

capacity sharing. Depending on seasonal conditions, the Intertie is

capable of transmitting up to 7,900 MW--4,800 MW of AC power (1,600

MW of this amount is in the California-Oregon Transmission Project,

also known as the ``Third AC Line'') and 3,100 MW of DC power. Over

the past five years, the limit has ranged between about 6,300 MW and

7,900 MW. Most of the power transmitted on the Intertie is surplus

to regional needs, but some firm power also is transmitted. See

http://www.nwcouncil.org/LIBRARY/2001/2001-11.pdf.

\18\ The third 500 kV line was installed between 2003 and 2004

in order to relieve constraints on the existing north-south

transmission lines. This capacity constraint contributed to the

California energy crisis in 2000 and 2001. See http://www.wapa.gov/

sn/ops/transmission/path15/factSheet.pdf.

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When the weather is hot in California and the Desert Southwest, it

is comparatively cool in the Pacific Northwest. Conversely, when the

weather is cold in the Pacific Northwest it is comparatively warm in

California and the Desert Southwest. Consumers on the West Coast take

advantage of seasonal weather differences to share large amounts of

power between the Desert Southwest and the Pacific Northwest. In the

spring and summer, when generators (mostly hydroelectric plants)

generally have surplus power in the Northwest and temperatures climb in

the Southwest, power is shipped south to help meet increasing power

demand, particularly for air conditioning. Conversely in the winter,

when generators in the Southwest generally have surplus power and

temperatures drop in the Northwest, power is shipped north to meet

increasing electricity demand, particularly for heating.

CAISO is charged with operating the high-voltage grid in

California. Because CAISO's service area is basically the entire state

of California, it is responsible for serving millions of businesses and

households, particularly in the Los Angeles and San Francisco areas.

CAISO's current mission is to ensure the efficient and reliable

operation of the power grid, provide fair and open transmission access,

promote environmental stewardship, facilitate effective markets,

promote infrastructure development and support the timely and accurate

dissemination of information. CAISO is responsible for operating the

hourly auctions in which the power is traded, and CAISO publishes LMP

data on its Web site.

1. Material Price Reference Criterion

The Commission's October 6, 2009, Federal Register notice

identified the SPM contract as a potential SPDC based on the material

price reference and material liquidity statutory criteria. The

Commission considered the fact that ICE sells its price data to market

participants in a number of different packages which vary in terms of

the hubs covered, time periods, and whether the data are daily only or

historical. For example, ICE offers the ``West Power of Day'' 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.

This package includes price data for the SPM contract.

The Commission also noted that its October 2007 Report on the

Oversight of Trading on Regulated Futures Exchanges and Exempt

Commercial Markets (``ECM Study'') found that in general, market

participants view ICE as a price discovery market for certain

electricity contracts. The study did not specify which markets

performed this function; nevertheless, the Commission determined that

the SPM contract, while not mentioned by name in the ECM Study,

warranted further review.

The Commission explains in its Guidance to the statutory criteria

that in evaluating a contract under the material price reference

criterion, it 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.\19\ 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 participants in pricing cash market transactions.

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\19\ 17 CFR 36, Appendix A.

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The SP-15 power market is a major pricing center for electricity on

the West Coast. Traders, including producers, keep abreast of the

electricity prices in the SP-15 power market when conducting cash

deals. These traders look to a competitively determined price as an

indication of expected values of power at the SP-15 hub when entering

into cash market transactions for electricity, especially those trades

providing for physical delivery in the

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future. Traders use the ICE SPM contract, as well as other ICE power

contracts, to hedge cash market positions and transactions--activities

which enhance the SPM contract's price discovery utility. The

substantial volume of trading and open interest in the SPM contract

appears to attest to its use for this purpose. While the SPM contract's

settlement prices may not be the only factor influencing spot and

forward transactions, electricity traders consider the ICE price to be

a critical factor in conducting OTC transactions.\20\ As a result, the

SPM contract satisfies the direct price reference test.

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\20\ In addition to referencing ICE prices, firms participating

in the SP-15 power market may rely on other cash market quotes as

well as industry publications and price indices that are published

by third-party price reporting firms in entering into power

transactions.

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The fact that ICE's SPM monthly contract is used more widely as a

source of pricing information rather than the daily contract (i.e., the

SDP contract) \21\ bolsters the argument that it serves as a direct

price reference. In this regard, the SPM contract prices power at the

SP-15 hub up to almost five years into the future. Thus, market

participants can use the SPM contract to lock-in electricity prices far

into the future. Traders use monthly power contracts like the SPM

contract to price future electric power commitments, where such

commitments are based on long range forecasts of power supply and

demand. In contrast, the SDP contract is listed for a much shorter

length of time--up to 75 days in the future. As generation and usage

nears, market participants have a better understanding of actual power

supply and needs. As a result, they can modify previously-established

hedges with daily contracts, like the SDP contract.

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\21\ The SDP contract is cash settled based on the arithmetic

average of peak-hour, day-ahead LMPs posted by CAISO for the SP-15

EZ Gen hub for all peak hours on the day prior to generation. The

LMPs are derived from power trades that result in physical delivery.

The size of the SDP contract is 400 MWh, and the SDP contract is

listed for 75 consecutive calendar days.

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The Commission notes that SP-15 is a major trading point for

electricity, and the SPM contract's prices are well regarded in the

industry as indicative of the value of power at the SP-15 hub.

Accordingly, the Commission believes that it is reasonable to conclude

that market participants purchase the data packages that include the

SPM contract's prices in substantial part because the SPM contract's

prices have particular value to them. Moreover, such prices are

consulted on a frequent and recurring basis by industry participants in

pricing cash market transactions. In these circumstances, the SPM

contract meets the indirect price reference test.

i. Federal Register Comments:

WGCEF, EPSA, WPTF, FIEG, EEI and ICE stated that no other contract

directly references or settles to the SPM contract's price. Moreover,

the commenters argued that the underlying cash price series against

which the SPM contract is settled (in this case, the average day-ahead

peak-hour SP-15 electricity prices over the contract month, which is

derived from cash market transactions) is the authentic reference price

and not the ICE contract itself. The Commission believes that this

interpretation of price reference is too narrow and believes that a

cash-settled derivatives contract could meet the price reference

criterion if market participants ``consult on a frequent and recurring

basis'' the derivatives contract when pricing forward, fixed-price

commitments or other cash-settled derivatives that seek to ``lock in''a

fixed price for some future point in time to hedge against adverse

price movements.

As noted above, the SP-15 hub is a major trading center for

electricity in the western United States. Traders, including producers,

keep abreast of the prices of the SPM contract when conducting cash

deals. These traders look to a competitively determined price as an

indication of expected values of electricity at the SP-15 hub when

entering into cash market transaction for power, especially those

trades that provide for physical delivery in the future. Traders use

the ICE SPM contract to hedge cash market positions and transactions,

which enhances the SPM contract's price discovery utility. While the

SPM contract's settlement prices may not be the only factor influencing

spot and forward transactions, natural gas traders consider the ICE

price to be a crucial factor in conducting OTC transactions.

In addition, WGCEF and EPSA stated that the publication of price

data for the SPM contract price is weak justification for material

price reference. Market participants generally do not purchase ICE data

sets for one contract's prices, such as those for the SPM contract.

Instead, traders are interested in the settlement prices, so the fact

that ICE sells the SPM prices as part of a broad package is not

conclusive evidence that market participants are buying the ICE data

sets because they find the SPM prices have substantial value to them.

As noted above, the Commission notes that publication of the SPM

contract's prices is indirect evidence of routine dissemination. The

SPM contract's prices, while sold as a package, are of particular

interest to market participants. Thus, the Commission has concluded

that traders likely specifically purchase the ICE data packages for the

SPM contract's prices and consult such prices on a frequent and

recurring basis in pricing cash market transactions.

Lastly, EEI argued that the ECM Study did not specifically identify

the SPM contract as a contract that is referred to by market

participants on a frequent and recurring basis. In response, the

Commission notes that it cited the ECM Study's general finding that

some ICE electricity contracts appear to be regarded as price discovery

markets merely as indication that an investigation of certain ICE

contracts may be warranted. The ECM Study was not intended to serve as

the sole basis for determining whether or not a particular contract

meets the material price reference criterion.

ii. Conclusion Regarding Material Price Reference:

The Commission finds that the ICE SPM contract meets the material

price reference criterion because cash market transactions are priced

either explicitly or implicitly on a frequent and recurring basis at a

differential to the SPM contract's price (direct evidence). Moreover,

the SPM contract's price data are sold to market participants, and

those individuals likely purchase the ICE data packages specifically

for the SPM contract's prices and consult such prices on a frequent and

recurring basis in pricing cash market transactions (indirect

evidence).

2. Material Liquidity Criterion

As noted above, in its October 6, 2009, Federal Register notice,

the Commission identified the SPM contract as a potential SPDC based on

the material price reference and material liquidity criteria. 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.

The total number of transactions executed on ICE's electronic

platform in the SPM contract was 3,235 in the second quarter of 2009,

resulting in a daily average of 50.5 trades. During the same period,

the SPM contract had a

[[Page 42385]]

total trading volume of 143,717 contracts and an average daily trading

volume of 2,245.6 contracts. Moreover, open interest as of June 30,

2009, was 460,583 contracts, which included trades executed on ICE's

electronic trading platform, as well as trades executed off of ICE's

electronic trading platform and then brought to ICE for clearing. In

this regard, ICE does not differentiate between open interest created

by a transaction executed on its trading platform and that created by a

transaction executed off its trading platform.\22\

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\22\ 74 FR 51264 (October 6, 2009).

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In a subsequent filing dated March 24, 2010, ICE reported that

total trading volume in the fourth quarter of 2009 was 311,819

contracts (or 4,797.2 contracts on a daily basis). In terms of number

of transactions, 6,199 trades occurred in the fourth quarter of 2009

(95.4 trades per day). As of December 31, 2009, open interest in the

SPM contract was 622,503 contracts, which included trades executed on

ICE's electronic trading platform, as well as trades executed off of

ICE's electronic trading platform and then brought to ICE for clearing.

The number of trades per day was substantial between the second and

fourth quarters of 2009. In addition, trading activity in the SPM

contract, as characterized by total quarterly volume, indicates that

the SPM contract experiences trading activity that is greater than that

of thinly-traded futures markets.\23\ Thus, it is reasonable to infer

that the SPM contract could have a material effect on other ECM

contracts or on DCM contracts.

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\23\ Staff has advised the Commission that in its experience, a

thinly-traded contract is, generally, one that has a quarterly

trading volume of 100,000 contracts or less. In this regard, in the

third quarter of 2009, physical commodity futures contracts with

trading volume of 100,000 contracts or fewer constituted less than

one percent of total trading volume of all physical commodity

futures contracts.

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To measure the effect that the SPM contract potentially could have

on another ECM contract staff performed a statistical analysis \24\

using daily settlement prices (between July 1, 2008 and December 31,

2009) for the ICE SPM and OFP contracts. The simulation suggest that,

on average over the sample period, a one percent rise in the SPM

contract's price elicited a 0.7 percent increase in ICE OFP contract's

price.

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\24\ Specifically, Commission staff econometrically estimated a

cointegrated vector autoregression (CVAR) model using daily

settlement prices. CVAR methods permit a dichotomization of the data

relationships into long run equilibrium components (called the

cointegration space or cointegrating relationships) and a short run

component. A CVAR model was chosen over the more traditional vector

autoregression model in levels because the statistical properties of

the data (lack of stationarity and ergodicity) precluded the more

traditional modeling treatment. Moreover, the statistical properties

of the data necessitated the modeling of the contracts' prices as a

CVAR model containing both first differences (to handle

stationarity) and an error-correction term to capture long run

equilibrium relationships. The prices were treated as a single

reduced-form model in order to test hypothesis that power prices in

the same market affect each other. The prices of ICE's SPM and OFP

contracts are positively related to each other in a cointegrating

relationship and display a high level of statistical strength. On

average, during the sample period, each percentage rise in SPM

contract's price elicited a 0.7 percent rise in OFP contract's

price.

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i. Federal Register Comments:

ICE and WGCEF stated that the SPM contract lacks a sufficient

number of trades to meet the material liquidity criterion. These two

commenters, along with WPTF, EPSA, FIEG and EEI argued that the SPM

contract cannot have a material effect on other contracts, such as

those listed for trading by the New York Mercantile Exchange

(``NYMEX''), a DCM. The commenters pointed out that it is not possible

for the SPM contract to affect a DCM contract because price linkage and

the potential for arbitrage do not exist. The DCM contracts do not cash

settle to the SPM contract's price. Instead, the DCM contracts and the

SPM contract are both cash settled based on physical transactions,

which neither the ECM or the DCM contracts can influence. The

Commission's statistical analysis shows that changes in the ICE SPM

contract's price significantly influences the prices of other ECM

contracts (namely, the OFP contract).

WGCEF and ICE noted that the Commission's Guidance had posited

concepts of liquidity that generally assumed a fairly constant stream

of prices throughout the trading day, and noted that the relatively low

number of trades per day in the SPM contract did not meet this standard

of liquidity. 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.'' \25\

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\25\ Guidance, supra.

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ICE opined that the Commission ``seems to have adopted a five trade

per day test for material liquidity.'' To the contrary, 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'' \26\ 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, the contract will not be found to be a SPDC merely

because it met the reporting threshold.

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\26\ 73 FR 75892 (December 12, 2008).

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ICE argued that the statistics provided by ICE were misinterpreted

and misapplied by the Commission. In particular, ICE stated that the

volume figures used in the Commission's analysis (cited above)

``include trades made in all months'' as well as in strips of contract

months. ICE suggested that a more appropriate method of determining

liquidity is to examine the activity in a single traded month of a

given contract.'' \27\ It is the Commission's opinion that liquidity,

as it pertains to the SPM contract, is typically a function of trading

activity in particular lead months and, given sufficient liquidity in

such months, the ICE SPM contract itself would be considered liquid.

ICE's analysis of its own trade data confirms this to be the case for

the SPM contract, and thus, the Commission believes that it applied the

statistical data cited above in an appropriate manner for gauging

material liquidity.

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\27\ In addition, ICE stated that the trades-per-day statistics

that it provided to the Commission in its quarterly filing and which

were cited in the Commission's October 6, 2009, Federal Register

notice includes 2(h)(1) transactions, which were not completed on

the electronic trading platform and should not be considered in the

SPDC determination process. The Commission staff asked ICE to review

the data it sent in its quarterly filings; ICE confirmed that the

volume data it provided and which the Commission cited includes only

transaction data executed on ICE's electronic trading platform. As

noted above, supplemental data supplied by ICE confirmed that block

trades are in addition to the trades that were conducted on the

electronic platform; block trades comprise about 66 percent of all

transactions in the SPM contract (as of the fourth quarter of 2009).

Commission acknowledges that the open interest information it

provided in its October 6, 2009, Federal Register notice includes

transactions made off the ICE platform. However, once open interest

is created, there is no way for ICE to differentiate between ``on-

exchange'' versus ``off-exchange'' created positions, and all such

positions are fungible with one another and may be offset in any way

agreeable to the position holder regardless of how the position was

initially created.

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ii. Conclusion Regarding Material Liquidity:

For the reasons discussed above, the Commission finds that the SPM

satisfies the material liquidity criterion. Specifically, there is

sufficient trading activity in the SPM contract to have a material

effect on ``other agreements, contracts or transactions listed for

trading on or subject to the rules of a designated contract

market[hellip]or an electronic trading facility operating in reliance

on the exemption in section 2(h)(3) of the Act.''

[[Page 42386]]

3. Overall Conclusion Regarding the SPM Contract

After considering the entire record in this matter, including the

comments received, the Commission has determined that the ICE SPM

contract performs a significant price discovery function under two of

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

Specifically, the Commission has determined that the SPM contract meets

the material price reference and material liquidity criteria at this

time. Accordingly, the Commission is issuing the attached Order

declaring that the SPM contract is a SPDC.

Issuance of this Order signals the immediate effectiveness of the

Commission's authorities with respect to ICE as a registered entity in

connection with its SPM contract,\28\ and triggers the obligations,

requirements--both procedural and substantive--and timetables

prescribed in Commission rule 36.3(c)(4) for ECMs.

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\28\ See 73 FR 75888, 75893 (Dec. 12, 2008).

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b. The SP-15 Financial Day-Ahead LMP Off-Peak (OFP) Contract and the

SPDC Indicia

The OFP contract is cash settled based on the arithmetic average of

off-peak hour, day-ahead LMPs posted by CAISO for the SP-15 EZ Gen hub

for all peak hours during the contract month. The LMPs are derived from

power trades that result in physical delivery. The size of the OFP

contract is 25 MWh, and the SPM contract is listed for up to 86

calendar months.

In general, electricity is bought and sold in an auction setting on

an hourly basis at various points along the electrical grid. An LMP

associated with a specific hour is derived as a volume-weighted average

price of all of the transactions where electricity is to be supplied

and consumed during that hour.

Electricity is traded in a day-ahead market as well as a real-time

market. Typically, the bulk of energy transactions occur in the day-

ahead market. The day-ahead market establishes prices for electricity

that is to be delivered during the specified hour on the following day.

Day-ahead prices are determined based on generation and energy

transaction quotes offered in advance. Because power quotes are

dependent on estimates of supply and demand, electricity needs usually

are not perfectly satisfied in the day-ahead market. Consequently, on

the day the electricity is transmitted and used, auction participants

typically realize that they bought or sold either too much power or too

little power. A real-time auction is operated to alleviate this problem

by serving as a balancing mechanism. Specifically, electricity traders

use the real-time market to sell excess electricity and buy additional

power to meet demand. Only a relatively small amount of electricity is

traded in the real-time market as compared to the day-ahead market.

Path 15 is an 84-mile portion of the north-south power transmission

corridor in California, forming part of the Pacific AC Intertie and the

California-Oregon Transmission Project.\29\ Path 15, along with the

Pacific DC Intertie running far to the east, completes an important

transmission interconnection between the hydroelectric plants to the

north and the fossil fuel plants to the south. Path 15 currently

consists of three lines at 500 kilovolts (``kV'') and four lines at 230

kV.\30\ The 500 kV lines connect Los Banos to Gates (two lines) and Los

Banos to Midway (one line); all four 230 kV lines have Gates at one end

with the other ends terminating at the Panoche 1, Panoche

2, Gregg, or McCall substations. ``NP-15'' refers to the

northern half of Path 15; conversely, ``SP-15'' refers to the lower

half of Path 15.

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\29\ The Pacific Intertie comprises three alternating current AC

lines and one direct current DC line. Together, these lines comprise

the largest single electricity transmission program in the United

States. The northern end of the DC line is at the Bonneville Power

Administration's Celilo Converter Station, which is just south of

The Dalles Dam about 90 miles east of Portland. The southern end is

846 miles away at the Sylmar Converter Station on the northern

outskirts of Los Angeles. That station is operated by utilities

including LADWP and Southern California Edison. The AC lines follow

generally the same path but terminate in Northern California. Only a

few parties actually own the Intertie, but numerous entities have

contracts to share its transmission capacity. The California-Oregon

border is a dividing line for Intertie ownership and capacity

sharing. Depending on seasonal conditions, the Intertie is capable

of transmitting up to 7,900 MW-4,800 MW of AC power (1,600 MW of

this amount is in the California-Oregon Transmission Project, also

known as the Third AC Line) and 3,100 MW of DC power. Over the past

five years, the limit has ranged between about 6,300 MW and 7,900

MW. Most of the power transmitted on the Intertie is surplus to

regional needs, but some firm power also is transmitted. See http://

www.nwcouncil.org/LIBRARY/2001/2001-11.pdf.

\30\ The third 500 kV line was installed between 2003 and 2004