Wholesale gas price ‘fixing’: the key questions

What are companies accused of?

It is alleged that the price of gas on 28 September was distorted and pushed below the market price, by a wholesale gas trader, or traders, deliberately selling it for less money than they could have. The traders (working for unnamed energy trading companies) then recorded this price with the price reporting agency ICIS Heron, as traders do every day.

The whistleblower also alleges that power companies “regularly” manipulate wholesale gas prices, which are used to set domestic energy bills. All of the Big Six energy companies vehemently deny the allegations.

Who raised the flag about potential price fixing?

Seth Freedman is the man behind the allegations. He worked at ICIS Heren, one of the companies that provide assessments of the price of gas, who is also a former trader and ex-Guardian contributor. The price reporter turned whistleblower, who recorded gas prices at ICIS Heren, was alarmed at the price and alerted his boss, who then told the energy industry regulator Ofgem and the financial services regulator, the Financial Services Authority (FSA). Both are now investigating.

Read more: Row erupts over consumer energy prices

How does the wholesale gas market work?

Energy companies are better known for how they sell gas to consumers. But they are also involved in buying it from its original source and trading within the market. As well as the Big Six companies, that dominate 99 per cent of the UK’s retail market, there are many more companies which trade gas, buying and selling it to all the providers. Gas is also required to fuel the energy market, so it is a crucial commodity.

How is the price set?

The price of gas is agreed privately between each buyer and seller, and then recorded by price reporting agencies towards the end of every day. These agencies also assess how much the seller asked for, and in this case, the agency recorded a problem because of the mismatch between the best bid, and the final amount paid.

The daily benchmark price set by ICIC Heren and others is significant because firms use them to negotiate future contracts and any change in the average daily price of gas affects how companies set their retail price, and what consumers pay. The day in question, 28 September, is particularly important because it marks the end of the gas industry’s financial year and can therefore influence prices in the future.

Why would companies want to lower gas prices?

This is the difficult bit for non-experts to understand, and depends on the type of company involved. Lowering the price of gas would benefit the bigger companies, more than the smaller ones. This is because big companies have a whole range of different contracts and products called derivatives, the price of which is linked to the price of gas.

So even if they take a hit on the gas price being lower on one day in the “spot” 24-hour market, the lower price could boost sales of derivatives. Overall the company may still profit from a lower rate. “It’s a way of managing risk of their portfolio of future contracts,” says Monica Giulietti, associate professor of global energy at Warwick University.

If prices were fixed, how would this affect the wholesale gas market?

If companies were keeping the price low, that is effectively pricing out competitors – especially those that are smaller and less able to trade on low prices. “It is possible that this makes it more difficult for other companies that would like to trade on the spot (daily) market,” Professor Giulietti told Channel 4 News.

And this is another reason why this issue has reached the House of Commons and is being taken so seriously: the energy regulator Ofgem has already raised concerns that the dominance of the Big Six companies is disadvantaging consumers, by allowing the big players much more power to dictate the tariffs they want. Energy companies have also been accused of racking up profits at the expense of consumers.

How would it affect consumers?

At the moment, it is difficult to measure the direct impact this could have on consumers, especially as wholesale gas prices affect future contracts. However previous evidence suggests that even if wholesale prices go down, that will not be passed on to consumers, according to Professor Giulietti. A 2011 Ofgem report found that when the price of gas goes up, the cost is passed on to consumer; but when the cost goes down, consumers pay the same and the company absorbs the cost.

The regulator and commentators within this market have been in discussion about the risks of unlimited transparency, limited liquidity, so there were concerns that pre-dated this issue. Professor Monica Giulietti

But by casting the wholesale gas market into the news, what the revelations have done is demonstrate the intricacies of the wholesale gas market at a time when Ofgem is calling for consumers to be better informed about the complicated retail gas market. Meaning that the whole industry appears even more mysterious.

Are the allegations a surprise?

The energy market has been under scrutiny for some time amid soaring consumer costs and a lack of transparency in how prices are set. So allegations that some companies may have been fixing prices to suit themselves is not wholly surprising, according to experts.

“The regulator and commentators within this market have been in discussion about the risks of unlimited transparency, limited liquidity,” said Professor Giulietti, “so there were concerns that pre-dated this issue.”

“I think it wouldn’t be surprising at all to find out markets aren’t functioning properly,” adds Stephen Fitzpatrick of the independent company, Ovo Energy.

The direct implications on smaller, independent energy companies such as Ovo, would have been more significant if it the allegations were of fixing prices upwards rather than down. But all the same, they raise significant issues about the industry, said Mr Fitzpatrick: “They have thrown up questions about price transparency – if you’ve got a small number of very dominant market participants, then this kind of activity is absolutely possible.”

How can the risk of fixing be diminished?

Consumer groups, and the smaller companies competing with the Big Six, argue that more regulation is needed. “There’s a lot of traders operating without a lot of scrutiny. It’s something that hundreds of millions of consumers are exposed to,” said Mr Fitzpatrick.

“If you think what the banking industry might look like if it hadn’t had such close scrutiny for the last four or five years – that comes close.”

David Cameron last week said he would legislate to force companies to put consumers on the lowest tariff – a statement that was then hastily retracted to remove the legal obligation. But with millions of British Gas customers being hit with price rises averaging 6 per cent later this week and other companies announcing price rises as the cold weather sets in, public opinion is not likely to improve until they are seen to take some of the burden away from people’s pockets.