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Canadian Discussion Paper Warns Regulators to Preserve LDC Merchant Function

Canadian Discussion Paper Warns Regulators to Preserve LDC Merchant Function

Canadian regulators should avoid forcing gas utilities out of the regulated merchant function, according to a new discussion paper by Roland George of consulting firm Purvin and Gertz. "System gas and direct sales gas can co-exist in the retail market," George said. The paper was released recently by the Conference Board of Canada and Canadian Gas Association (CGA), which represents Canada's local distribution companies (LDC).

"The main conclusion of this paper is that system gas [or gas procured by utilities on behalf of retail customers] has an important role to play in the efficient, reliable and safe functioning of the natural gas industry as a whole and more specifically of regulated natural gas distribution," George said in the paper titled "System Gas in a Regulated Market.

First of all, most small retail customers prefer buying system gas from utilities to buying gas from retail marketers, he said, "although direct gas sales from unregulated marketers have also been chosen by a significant number of retail customers."

Secondly, system gas provides other operational benefits and supply security at a time when that is desperately needed. "LDCs need to procure natural gas for operational reasons such as load balancing and linepack," according to the paper. "Procuring it also ensures that LDC's retain the incentive to...support infrastructure investments [in] their market area and ensure capital renewal and growth within their franchise area.

"This is especially important in an era characterized by supply concerns and a lack of market participants with the will and capability to provide support for the industry's infrastructure," according to the paper. "Furthermore, no other market participant combines the commercial interest and ability to undertake the system planning and operational integrity roles fulfilled by the LDCs for their particular region." The regulated merchant function provides a "competitive check" on the potential exercise of market power by an unregulated and dominant retail market company.

However, one of the more common arguments against trying to retain the merchant role for utilities while at the same time promoting customer choice is that it allows the utility an unfair competitive advantage over the unregulated merchants. Given its responsibilities as the gas distributor, transporter and its other regulated services, the LDC could rely on its vertical integration efficiencies to exert market power. Barriers could be erected in the billing systems or the treatment of load balancing and deviations, for example.

"Legislators and regulators are aware of these issues," said George, "and have been continuously addressing them since a more market-driven approach was initiated nearly two decades ago."

Nevertheless, he added, regulators need to take several actions to ensure there is the proper balance between regulated supply service and unregulated supply:

  • ensure appropriate cost accounting by LDCs;
  • a billing system that provides adequate information for decision making by market participants and allows for creative service offerings; and
  • ensure proper treatment of load balancing and deviations.

"The goal of a fair and efficient retail market that provides customer choice should be the sieve that determines which other issues should be examined," George said. "Facts and analysis, not ideology and emotion, should be the starting point for policy making."

Regulators also need to reassure regulated utilities that there will not be an eventual disallowance of gas supply costs because that possibility would create an underlying disincentive to support required investments in infrastructure. "To address this problem, regulators should provide before-the-fact gas supply policies and guidelines," George said.

For more details from this paper and four other gas policy papers that were released, go to http://www.cga.ca/publications/CGASponsoredStudies.htm.

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