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By Scott DiSavino Aug 5 (Reuters) - U.S. federal energy regulators on Mondayordered BP Plc to respond to allegations of natural gasmarket manipulation in Texas, threatening the energy companywith fines near $29 million. The move likely sets up another major legal battle for theFederal Energy Regulatory Commission (FERC) as it steps uppolicing of power and natural gas markets. In the order, FERC pointed to a two-minute recordedconversation between a BP trainee and a senior gas trader asevidence that BP bought and sold gas at a possible loss in thephysical market in order to increase the value of BP'sderivatives position. BP said the recorded call was "taken out of context." Thecompany will "vigorously defend against these allegations,"spokesman Geoff Morrell said in a statement. He said the chargeswere "without merit" and that BP stood by public statementsissued in February 2011 that maintained that the gas traders didnot engage in market manipulation. The commission said BP has 30 days to pay the fine orcontest the order. FERC has another contentious legal case brewing withBarclays Plc, which last month vowed to fight a $470million fine for allegedly manipulating California powermarkets. JPMorgan Chase & Co settled a separate case for $410million last week. FERC first notified BP that it was investigating thecompany's trading in the Houston natural gas market about twoyears ago. FERC is seeking penalties of $28 million and thereturn of $800,000 in profits, plus interest, it said on Monday. The proposed fine for BP is much smaller than others FERChas pursued over the 18 months of its crackdown on manipulativetrading. Congress bolstered FERC's enforcement power in 2005following the California energy crisis and the Enron scandal. BP paid $303 million to the U.S. Commodity Futures TradingCommission in 2007 to settle allegations the company tried tomanipulate the propane market in 2003 and 2004. Since then, BPhas clamped down on trader pay and oversight. The FERC order said that the natural gas trading activitywas reported to an internal BP compliance group establishedafter the 2007 propane settlement. FERC said that while BPconducted an internal investigation, it had failed to take theprobe "seriously" and had failed to collect "critical" tradingdata from the period. Traders and executives have questioned whether FERC isfocusing on trading practices that are less obviouslymanipulative than the Enron-era scandals of a decade ago,leading some to say it is unnerving many in the industry. SUPPRESSED VALUE FERC alleges that BP's traders used the company'stransportation capacity between two natural gas hubs in Texas,Katy and the Houston Ship Channel, in a manner that suggested BPwas trading to benefit another position. Going into September 2008, FERC said BP had positions thatwould rise in value if prices at the Houston Ship Channel fellrelative to those at Henry Hub in Louisiana, the delivery pointfor the benchmark U.S. natural gas futures contract. When Hurricane Ike made landfall near Galveston, Texas, onSept. 13, 2008, Houston Ship Channel prices plummeted as manysmall intrastate pipelines were shut in, resulting inlower-than-normal flows of gas out of the Houston region. FERC said this meant the company's position was suddenly worth millions of dollars, but only if Houston Ship Channelprices stayed depressed until the end of the month. FERC said senior BP gas trader Gradyn Comfort, with thecooperation of two colleagues, Nesha Barnhart and ClaytonLuskie, began selling physical gas at loss-making prices in theHouston Ship Channel around Sept. 18. Because the alleged scheme appeared to be working, FERCsaid, the traders extended the trading strategy into November2008. To implement the plan, FERC said the traders "only had toexpand their existing positions and exploit more of the(company's) transport capacity, rather than justify an entirelynew trading strategy to their supervisors." FERC'S CLAIMS FERC said the "manipulative scheme" was discovered whenLuskie was at a BP trader-training program in November 2008 and"tried to impress a senior BP trader by explaining the team'sscheme," FERC said. Luskie had only worked for the firm sincethat August. When the senior trader questioned the legality of theirstrategy, Luskie called Comfort, a trader with 17 yearsexperience, on his number at the trading desk - a recorded line. On the Nov. 5, 2008, recorded call, FERC said Luskierepeatedly asked Comfort for a legitimate explanation of theteam's physical trading. "So how would you explain our, um, our dealings on (HoustonPipeline) and with our paper position that don't make it soundlike we're manipulating the index?" Luskie asked Comfort,according to the FERC order. Comfort's initial reaction was to cut off Luskie'squestioning, FERC said. When pressed further by Luskie, Comfortmade a few short statements, interspersed by long pauses. Luskie subsequently called back on an unrecorded cell phonecircuit, FERC said. BP denied its traders did anything wrong and said "FERCbases its allegations on a recorded two-minute phoneconversation between a BP trainee and BP natural gas trader thatthe regulator has taken completely out of context." "The recording does not support any allegation ofwrongdoing," BP's Morrell said. "In fact, the trainee involvedin the conversation states that his characterization wasincorrect and the trader never agrees with nor condones thetrainee's statements." Despite Comfort's repeated interruptions, FERC said Luskie'sstatements on the recorded call were sufficient to provide staffwith an outline of the traders' scheme, which the underlyingtrade data confirmed.