Calling it an “important moment” for natural gas regulation,FERC last week proposed lifting the price caps on capacity in theshort-term market and allowing pipelines to negotiate the terms andconditions of service subject to certain restrictions. With theseand other proposals, which elicited encouraging initial reactionsfrom industry, the Commission formally launched the mostcomprehensive review of its gas regulations since Order 636.

“We have bitten off quite a lot…,” said Chairman James Hoeckerin issuing a notice of proposed rulemaking (NOPR) on regulation ofshort-term transportation services and a notice of inquiry (NOI) onregulation of interstate gas transportation services. He noted thatFERC commissioners undertook “both courageous and cautious” stepsin the NOPR and NOI, which were the end product of nearly a year ofdebate.

“…[T]o those who expect from this effort something radical,something one-sided or who fear something irresponsible, you willbe sorely disappointed. But if, however, you value innovation andthe opportunity for constructive discussion on a whole range of keyissues about how to make a good market better, you will be morethan pleased I think,” Hoecker said. “This proceeding may not bethe milestone that 636 was, but it may be something better yet – anew focus on making regulation more market responsive.”

The cornerstone of the NOPR proposes the removal of existingprice caps on short-term (less than one year) firm, interruptibleand capacity-release capacity [RM98-10]. But the proposal was notmade willy-nilly, Commissioner William Massey said. “It is coupledwith a number of protections, such as a requirement that allavailable short-term capacity be sold through an auction, arequirement that all short-term services have the same levels ofscheduling and nominations purposes to ensure that short-termservices will be comparable to one another [and can better competewith pipeline capacity], a requirement that released capacity havethe same segmenting rights as pipeline capacity also to ensurecomparability, [and] reporting requirements that will allow theCommission to monitor for entities that might try to withholdcapacity for a higher price.” It also proposes reforms to penaltyprocedures. All of the proposed protections are aimed at mitigatingthe potential market power of pipelines and shippers in theshort-term market once prices are deregulated.

Specifically, in return for removing the price caps, allshort-term capacity – whether it be release capacity or pipelineowned – would be sold through capacity auctions, according toFERC’s proposed rulemaking. Under the auction process, pipelineswould be required to sell all available short-term capacity on adaily basis at or above the minimum variable cost of the capacity.They wouldn’t be permitted to withhold any capacity from shippers.

Producers were both “encouraged” and “intrigued” by the auctionproposal. “Quite frankly, we were fearful that it [the Commission]was going to go in the other direction” towards direct brokering,said Philip Budzik, director of federal regulatory affairs at theNatural Gas Supply Association (NGSA). Direct brokering of capacityis “less public and more susceptible to manipulation” than capacityauctions, he noted.

The American Gas Association (AGA), which has supported theremoval of price caps, reacted cautiously on this issue. “We haveto look at the details of how they’ve done that because they [FERC]have proposed some new things that haven’t been really discussedyet in the industry,” such as capacity auctioning, noted JaneLewis, senior counsel and director.

Commissioner Linda Breathitt noted that while the NOPR provideda “good theoretical framework” for the daily auctioning ofcapacity, she questioned how and whether it would work under “realworld conditions.” Her major concerns centered on “how will theintra-day nominations work in a daily auction, how can contingentbids be handled when timing is so critical, how will the featuresof capacity release – such as the releasing shipper’s recall rights- work in conjunction with the auction, and what are the costs andwho will pay them.” Breathitt also believes the auctions will haveto be conducted over the Internet to be effective.

“…[I]t seems that it will be up to the creativity of theindustry to resolve the implementation issues that will arise withregard to a daily auction,” she said. Commissioner Vicky Baileyconcurred, noting that FERC will need “the best thinking of theindustry on how such a process can work best, and what theramifications of an auction process will be on particularpipeline[s] or in specific regions.”

The NOPR also proposes that pipelines be allowed to negotiateterms and conditions of service in both the short- and long-termmarkets, provided they comply with several filing and reviewrequirements. These include: 1) an initial filing enabling shippersto take an active role in determining what constitutes a recourseservice; 2) a list from each pipeline of the terms and conditionsthat will be non-negotiable; 3) a 30-day notice requirement ofnegotiated deals that may affect other shippers, and a 10-daynotice requirement for all other negotiated deals; 4) more detailedfiling requirements that will enable shippers to determine whethera negotiated deal will impact their services, or whether they aresimilarly situated with a shipper receiving a negotiatedtransaction; 5) periodic reviews of recourse services to ensuretheir viability; and 6) a requirement that allows negotiation ofterms and conditions between a pipeline and its affiliate as longas other similarly situated shippers on its system have beenoffered the same deal.

Producers, who have been opposed to negotiated services, saidthey were “encouraged” by this proposal because of therestrictions. “I’m not saying that we’re fully on board…but I’mencouraged that the Commission is looking out for the interests ofthe customer by putting some of these restrictions on negotiatedterms and conditions,” said NGSA’s Budzik.

AGA also seemed to like the Commission’s proposal for negotiatedservices. “I think the proposal…is designed to allow someflexibility in individual contracting practices, while at the sametime [it tries] to ensure that recourse customers are protected andkept whole. I think it is a cautious approach,” Lewis said. Shenoted it incorporates some of the basic tenets of the negotiatedplan submitted by AGA and the Interstate Natural Gas Association ofAmerica (INGAA) last May.

Massey expressed several concerns about giving pipelines theauthority to negotiate their services. For one, “I have not heard ahue and cry from shippers requesting negotiated terms andconditions. Indeed, [it’s been] quite the opposite.” Before actingon a final rule, “I will need to hear from shippers that can makethe case that negotiated terms and conditions will benefit them.After all, they [are] the users of the system.”

Moreover, Massey questions whether negotiated terms andconditions will be viable in a short-term market with dailycapacity auctions. “Quite candidly, I haven’t figured out how wecan couple” the two. Should negotiated terms and conditions belimited solely to the long-term transportation market? he asked.

The Commission’s proposal “makes a serious attempt at balancingthe needs of the short-term market without creating a bias againstlong-term transactions,” Massey noted. Toward that goal, the NOPRproposed removing the five-year matching term for right-of-firstrefusal. It also takes a close look at how the Commissiondetermines “need” when certificating pipeline projects. Some of the”critical questions” it posed are: “Should the Commission considermore than just precedent agreements or contracts to assessindependently the market’s need for additional capacity?” and”Should the Commission apply a different standard where certificateapplications are supported primarily by contracts with affiliatesas opposed to non-affiliates?”

The NOI, on the other hand, is “simply an exploratory journeywith respect to pricing issues for the future” in the long-termtransportation market, Bailey noted [RM98-12]. “The Commission setsforth several ideas on cost-based and market-based pricing modelsthat could be explored…Some of the ideas have been around theblock before, some are new.” The NOI, for example, takes a look atrate indexing and incentive rates as possible alternatives totraditional cost-of-service ratemaking, a FERC staff member said.In addition, it asks the gas industry to comment on the future ofstraight-fixed variable rate design. Comments on the NOI and NOPRare due within 90 days of their publication in the FederalRegister.

Susan Parker

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