Another Bank is Caught Messing With Energy Markets — What Will Stop Them?

On Wednesday, JP Morgan paid $410 million in a settlement with the Federal Energy Regulatory Commission over 12 “manipulative bidding strategies” to alter prices in regional energy markets in the Midwest and California from September 2010 to June 2011. 

FERC was not specific in its press release about what these strategies were, but two of them involved JP Morgan traders putting in low bids for energy contracts from power plants owned by its energy subsidiary at the end of a market day, so that the price would be driven up the next morning. This is when service providers like the California ISO, a nonprofit government organization supplying electricity, would be forced to buy at higher prices.

This is not the first the time the FERC has targeted banks in the domestic energy market. On July 16, Barclays paid out $487.9 million in fines and penalties for manipulating energy markets in the Western U.S. between 2006 and 2008. Deutsche Bank paid $1.6 million to resolve a FERC dispute in January. And back

in 1996, JP Morgan’s commodity trading unit was involved in a scandal with copper trading. It wound down that business by 1998 in the wake of the controversy.

The difference between this penalty from FERC and the other cases, both this year and in 1996, is that JP Morgan Energy Ventures Corp. (the wholly owned subsidiary) is only charged with price gouging within the market. In the other cases, these manipulations were used to trade on derivatives relating to the energy market.

JP Morgan has decided to potentially divest itself from the issue, declaring last Friday before the ruling that it could sell off major aspects of its commodities business.

It seems to be heading off a storm – the Federal Reserve announced two weeks ago that it would review its 2003 decision to allow investment banks to operate in the commodities market and last week the Senate Banking Committee held hearings on the issue. 

Two Sundays ago, the New York Times kicked off this regulation bonanza with an investigative piece on Goldman Sachs’ role in the aluminum trading business. After buying aluminum storage facilities, the bank increased spot prices by increasing the warehouse time from weeks to months.

The real money was made here not on these margins, but by trading on aluminum-based derivatives with knowledge from the storage business. It would not be surprising if JP Morgan's activities involved passing on information to its parent traders as well.

The FERC fine allowed JP Morgan to neither "accept or deny allegations," which seems like an ambiguous space in the law. Most of what has taken place under the bank's purview is not illegal, but it is detrimental on two levels.

When it comes to commodities, local or regional monopolies are a real possibility. Just because there might be another power plant one city over does not mean that these sources of energy are in competition. The transport costs and infrastructural lock-in of many commodities mean there’s an opportunity for sellers to gouge the price. This is textbook deadweight loss — maybe good for one company but bad for the market, and ultimately society.

Second, and particular to investment banks, is the possibility to use information from operating these businesses to inform their trading on commodities-based derivatives. However you spin it, this is insider trading. Once a company can own both businesses, it seems almost impossible to enforce any prohibition of this exchange of information.

Some will see these practices as unjust, corrupt, and generally deplorable. There’s a lot of truth to those criticisms. But ultimately, until it is illegal and then some, someone will do it. Instead, it might be more prudent to focus on aspects of such trading that are unambiguously bad for the economy. Investment banks may not like that, but it will be hard for them to criticize the thinking behind it.