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Proposed Market-Based Rates for Storage Stir Up Conflicting Comments

FERC's proposal to loosen the rules for granting market-based rates for new natural gas storage projects, with the goal of speeding an increase in storage capacity and thereby mitigating market peaks and valleys and consequently price volatility, has brought a storm of comments from interested parties on how the rules should be written.

Comments on the Notice of Proposed Rulemaking [RM05-23, AD04-11] range from a preference for regulated storage, to the question of whether market-based rates should be allowed only for new stand-alone projects or also include expansions of existing storage, to advice on how to avoid affiliate subsidization, and to comments on the loosening of the market power test and a proposal that the traditional Herfindahl-Hirschman Index (HHI) assessment cut-off level be changed.

FERC has proposed to use two methods to encourage storage construction by allowing developers to use market-based rates. One would expand the alternatives that could be considered in the test for market power to include pipeline transportation or LNG which could serve the same market, instead of limiting comparative alternatives to other storage operations. The second item would carry out the direction of Congress in the Energy Policy Act of 2005 which amended the Natural Gas Act by adding Section 4(f) to allow market based rates for facilities that had market power if FERC determined the facilities were in the public interest and consumers would not be harmed (see NGI, Dec. 19, 2005).

There were conflicting opinions from independent storage developers and pipeline storage operators.

Falcon Gas Storage Co. Inc. agrees with the Commission's proposal for loosening the market power test and for granting market-based rates even if the storage provider has market power, if the Commission determines it is in the public interest -- but, FERC should beware of misuse of the new rules by storage providers affiliated with pipelines or electric utilities. These should not be allowed to subsidize service through rolled-in rates, bundling or other preferences.

Falcon, which describes itself as the largest privately owned storage operator and developer, with 22 Bcf of working gas capacity and another 50 Bcf under development, notes the "increased concentration in the pipeline industry and the emergence over the past several years of large publicly traded partnerships or limited liability companies as owners and operators of natural gas pipelines and storage facilities."

Falcon points out that market economics forces independents to build storage to fit the circumstances of a particular market, while affiliates have an incentive to serve the existing infrastructure of their affiliates notwithstanding market conditions. Additionally, independents naturally favor hub building and interstate systemwide integration.

Affiliated storage providers may rely on existing infrastructure and subsidize their storage operations with, among other things, firm transportation rates and preferential tariff terms and conditions, Falcon claims. They also often charge bundled rates for storage and other services such as park and loan and imbalance management. And they may gain an artificial market advantage through preferential rate zone boundaries, interconnection policies and scheduling and imbalance procedures. Pipeline and utility affiliates with access to internal capital may be able to charge below market rates to squeeze out competing independents who must pay back outside investors.

Falcon noted that in the past it has asked the Commission to unbundle storage and transportation services and allocate the appropriate level of fixed and variable costs to storage and transportation services so independents can compete on a level playing field. FERC should require affiliated storage developers to demonstrate that the new projects will have their own financial base with no cost shifting.

EnCana agreed, saying affiliated developers should not be able to roll the costs of failed projects into other customer's rates. The producer outlined a number of procedures FERC could install in its authorization process to guard against cross-subsidization which would distort competition.

EnCana, which lays claim to the title of the largest independent natural gas storage operator in North America with 39 Bcf in the United States, another 29 Bcf under development, and 125 Bcf in Alberta, also said expansions of existing capacity should not be allowed to qualify for market-based rates since it would be impossible to separate out costs so existing customers did not subsidize the cost of the expansion. The producer/storage operator notes FERC has consistently denied proposals that would result in dual regulatory facilities because it would not be able to adequately regulate the jurisdictional services and there is no way to protect existing customers.

EnCana also believes all those proposing market-based rates should be required to file a market power analysis -- including proposals coming in under Section 4(f) -- which FERC could then use to develop terms and conditions to ensure customers are not harmed. Further, the Commission should be concerned about protecting not just customers, but competition and competitors.

Falcon believes FERC shouldn't focus solely on salt cavern storage for the high deliverability needed for the market. "The NOPR's suggestion that only salt cavern storage possesses the requisite flexibility and deliverability to supply gas on an as-needed basis is significantly overstated," besides being outside the purview of the proposed rules change.

"Reservoir storage, with the appropriate number of properly-configured wells and attendant surface facilities, can very closely match the operating characteristics of salt cavern storage, typically at a fraction of the unit development cost." Falcon operates both salt cavern and high deliverability, multi-cycle (HDMC) reservoir storage, and notes its Hill-Lake HDMC facility in north Texas has a swing capability of up to 50,000 MMBtu/hour, "enough to accommodate the typical hourly swings needs of approximately 10,000 MW of gas-fired electric generation."

Its MoBay HDMC reservoir storage project in Alabama is designed for a swing capability of up to 100,000 MMBtu/hour. "At the same time these HDMC reservoirs also can be cost-effectively utilized to capture the $2.00-$3.00 per MMBtu off-peak to winter peak arbitrage spreads that the market is currently seeing on the Nymex, which salt cavern storage is not optimally designed to do."

On the other side, Kinder Morgan Interstate Pipelines urged the Commission to allow market-based rates for expansions of existing facilities, to raise the HHI formula threshold for a presumption of not having market power from 1,800 to 2,500 and to clarify that the periodic review requirement would not be a basis for overturning contracts entered into prior to the review.

Kinder Morgan, which has said it plans to build storage along with its new Rockies Express pipeline (see separate story), maintains there is no rational basis for not allowing expansions of existing facilities to qualify for market-based rates under the new formula. The idea is to push the development of increased storage capacity, and "all increases in capacity have equal benefits to the market.

"Frequently, it is faster and more cost effective to create additional storage capacity through the expansion of existing storage fields," since the existing storage provider will have experience with the geological characteristics and performance parameters. Also, pipeline connections would be in place and expansions may require little or no additional cushion gas. "In today's market, the presence of existing cushion gas is a significant factor, since new cushion gas does not have to be purchased at current market prices. It makes sense to take full advantage of the existing expertise and assets."

The pipeline also noted that FERC's processing time for an expansion can be considerably shorter than the time necessary for a greenfield project. For instance, an addition to Kinder Morgan's Natural Gas Pipeline storage took a year to process, while a brand new project can take as much as three years.

If market-based rates were available to greenfield projects, it would give those developers an advantage since it would allow the developer and the customer to agree on contract terms and prices without any regulatory scrutiny. This flexibility -- as opposed to a set tariff -- allows each party to bargain for what is most important to them...a long term contract or price protection.

"Pricing flexibility in the absence of market-based rates is circumscribed and is subject to FERC review, creating regulatory risk even with negotiated rates," Kinder Morgan said.

While the pipeline applauds FERC's proposed expanding consideration of competing alternatives in determining whether a new project will have market power, it believes FERC also should re-examine the level of concentration it is using to determine market power. Kinder Morgan points to the HHI level of 2,500 as one used by the Department of Justice in its recommendations for evaluating market power in oil pipeline cases.

Also, the courts have recognized that other economic factors, including buyer power, may offset market power. "In today's gas market, purchasers of storage capacity are generally large local distribution companies or even larger and more powerful marketing arms of large producers. The presence of buyer power, however, is not accounted for in the Commission's HHI analysis, even though the courts have found that '[e]mperical studies have shown that the stronger and more concentrated the buyers' side of the market is, the less is any ability of sellers to elevate their prices.'"

FERC's adoption of the 1,800 HHI standard is too restrictive and was developed to deal with mergers among competitors and should not be applied to new storage development, an entirely different thing. Even relating to mergers, the pipeline pointed out that the vast majority of mergers challenged by the Justice Department or the Federal Trade Commission involved markets characterized by HHIs of 2,400 or higher.

Kinder Morgan also does not believe there should be a periodic review requirement, noting that in the past companies with market-based rates have merely been required to report structural changes such as mergers or acquisitions, which could affect the market power evaluation. If a review is imposed, it should not be allowed to overturn contracts since this would defeat the market-based rate operation.

Large producers in the Natural Gas Supply Association (NGSA) support FERC's goal of increasing storage by encouraging additional investments, "but this can be accomplished without changing the traditional market-power test," said Patricia Jagtiani, the group's vice president of regulatory affairs. "It is a test that has successfully withstood the test of time."

"Since 1996, FERC [has] had 40 requests from storage operators for market-based rates and approved all but one. There is no need to proceed with such massive changes to the market-based test based on these percentages, one out of 40," the producer group said. "Existing storage facility owners made their investment decisions during a period in which the EPAct options did not exist and obviously believed that they could successfully recover their costs as well as a return on equity sufficient to cover the risk of their investment."

NGSA also does not believe operators of cost-based storage should be allowed to change over to market-based without passing a market power test.

The American Gas Association (AGA) also came out against changing the market power test, which the group said would not encourage new storage, but would allow existing storage to change over to market-based rates. The principal holders of existing cost-based storage are major pipelines, AGA said, worrying the pipeline storage operators would raise the rates charged to distribution company customers. Also, the second part of FERC's proposal, to allow market-based rates as long as FERC determined it was in the public interest, should not be applied to expansions of existing storage.

While the American Public Gas Association (APGA) believes there may be a need for more storage capacity, it must be "the right kind of storage capacity. Regulated storage capacity -- that will assure that the storage provider will provide service and do so on a non-discriminatory basis -- may theoretically provide a modulating influence on natural gas prices.

"On the other hand, unregulated storage service in the form of market-based rates, particularly if the storage provider can exercise market power, can exacerbate the upward pressures on natural gas prices during periods of peak demand," APGA said. A storage operator is more likely to hike his own prices when gas is in short supply, thereby pushing prices even higher during times of peak demand. This can only happen if a storage operator has market power, which is why it is important that FERC not relax its restrictions on market power.

APGA said there is no reason to think the 700 Bcf of additional storage capacity that FERC believes is needed by 2025 will not develop without new incentives. The muni group points out that according to a staff report published Sept. 30, 2004 projects already certificated and expected to be filed in the near future would meet that target.

Lack of storage capacity in certain regions cannot be remedied with a rules change, several commenters point out. The bedrock underlying much of New England has something to do with the lack of gas storage facilities there, as does the lack of access to supplies and political constraints.

APGA believes the Commission should cap the price of long-term storage service (1 year or more) and require tariff terms and conditions for the service. Storage service should be sold in an open season process with long-term contracts having a right of first refusal. Only if there is capacity left over may an operator sell it at market-based rates for short term service. There must be a Commission-approved auction procedure, information must be provided and records kept for a FERC review every three years, the municipals said.

Another customer group, the Process Gas Consumers (PGC) noted that existing storage operations should not be allowed to switch to market-based rates because that would not further the NOPR's goal of incentivizing new storage by lessening the risk of constructing it. Likewise, an extension of existing storage does not face the same risks as a new venture. "For example, existing facilities may increase capacity by decreasing the level of cushion gas and increasing the working gas and the recycling of working gas, while new facilities are burdened with the substantial cost of injecting cushion gas..."

The large gas consumer group also notes that relaxing the market power test is unnecessary since Section 4(f) allows certification of facilities that have market power unless they are not in the public interest or do not have consumer protections. A review of facilities every five years is necessary and FERC should hold a technical conference to develop specific methods for preventing the withholding of capacity or the extraction of monopoly rents. PGC would like to see universal safeguards and applicants also should have to demonstrate that consumers are adequately protected in development of their specific project.

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