FERC’s proposal to organize and monitor the short-term marketthrough daily auctions is either a belated and unnecessaryadministrative nightmare – or the road to vigorous competition inthe transportation market, i.e. the “commoditization” oftransportation.

Those were the views expressed during sessions and in thehallways last week at the DOE-NARUC Natural Gas Conference inPittsburgh, with industry mostly lining up behind the “nightmare”scenario and regulatory types espousing the competitive theme.

One expert on regulatory issues has suggested that seeing theentire gas industry “apparently marching against the proposedoption” in lockstep is a good sign that FERC is on the right trackin its effort to create “vigorous price competition.”

The daily auction concept, which was proposed in a July noticeof proposed rulemaking (NOPR), is making “interesting bedfellows”of pipelines, distributors and marketers, said Pam Prairie,director of the Institute of Public Utilities at Michigan StateUniversity. “…[C]ompanies like Dynegy Corp. are taking a positionin opposition to the auction; pipelines don’t like the auction ideafor obvious reasons; and LDCs, I think, are still trying to sorttheir way through as to whether or not the auctions are good orbad.”

More to the point, “all the sellers [of short-term capacity] arereally concerned that something’s going to happen to their prices,”she said. But Prairie doesn’t think all parties have cause forconcern. “If you’re a buyer, I think [the auction’s] good news, andif you’re a consumer of gas, I would suggest that that’s also goodnews for you because if there’s vigorous price competition in thesecondary market prices should go down.”

In the NOPR, the Commission proposes to require the auctioningof short-term (less than one year) firm, interruptible andcapacity-release capacity as a condition to removing the price capsin that market. A daily auction would be the “linchpin” to removingprice caps on short-term transportation, said FERC CommissionerLinda Breathitt. “Without the kind of market power mitigation thatthe daily auction is meant to provide, I will be unwilling tosupport release of the price cap for short-term transportationservices,” she vowed. Breathitt’s unyielding statement was inresponse to industry rumblings that it would be an administrativenightmare to coordinate buying gas and successfully participate inseparate auctions for pipeline paths to markets for multipletransactions – all for delivery the next day.

Although the aim of the auction is to mitigate the existingmarket power particularly held by pipelines in the short-termmarket, Prairie believes it is “equally important” that regulatorsfocus on LDCs and marketers, which she said also could hold enoughcapacity in the secondary market to wield considerable marketpower.

This is a real threat since more and more marketing companiesare signing contracts with LDCs to manage distributors’ portfolios,she noted. In such cases, “it’s not difficult to imagine a scenarioin which [a] marketer can keep a competitor’s gas supplies bywithholding large chunks of capacity at the LDC’s citygate [frombeing released]. Or by withholding capacity from the releasemarket. they [marketers] could also create a scarcity circumstancewhich, in turn, would drive up [the] price for released capacityinto that market.”

Likewise, “it is not difficult to imagine a scenario [where]several pipelines would get together and create a new marketingaffiliate…that could buy firm capacity from [one of the pipelinesat] below tariff rates with the intent of re-selling the capacityat market-based prices in the secondary market,” Prairie noted.

What FERC is asking from the gas industry in the megaNOPR – tocreate a whole new way of selling short-term capacity – is a”formidable task,” but it’s “also a very doable task,” she toldNGI. Prairie said from her experience with implementation of Orders436 and 636 when she was an executive with ANR Pipeline it takes18-24 months and massive resources for system users to install andbecome familiar with a new process and figure out how to optimizeservices.

“If we really want to get to a competitive market, we can’t usethe excuse that there’s an administrative burden…as a barrier tonot getting there,” she said. Prairie was partly referring to arecent request by six trade associations for the Commission toextend until Jan. 22 the deadline for the gas industry to respondto the NOPR and the notice of inquiry (NOI). The comments on bothinitiatives, which were issued in late July, are due Nov. 9th. Thegroups sought the extension because of the number of the issues(200 in all) that FERC asked them to address in written comments(See NGI Oct. 5).

Part of the problem, one industry representative pointed out isthat FERC only came up with a concept and left it to the industryto figure out how to make it work. Some sources said last week theyhave not even begun trying to figure out how it might beaccomplished. One said his group still was in the process of hiringan economic consultant.

Another who had looked at the problem said the main issue wouldbe sequencing. The difficulty would lay, he said, in buying gas andthen successfully participating in multiple pipeline auctions inyour path to market for gas to be delivered the next day. Failurein any part of the process would cause the whole transaction tocollapse. Multiplying this by the number of transactions variouscompanies are involved in everyday is where the nightmare comes in.

Another industry source pointed out that LDCs have been tryingto get FERC to fix the capacity release program since the firstyear it was implemented. After its most recent attempt to installpilot programs in late 1996 failed, most in the industry hasfigured out how to get around the rules, including price caps,through pre-arranged deals and gray market transactions.

If, as Prairie pointed out it takes industry 18 to 24 months toadapt to new programs, then the five years since capacity releasewas installed in Order 636 has been more than enough time foradaptations to occur. Several LDCs commented that removing theprice cap certainly wasn’t worth the cost and effort of installingand learning a whole new auction process. The protests thatoriginally greeted the price cap have died down. As one LDCrepresentative put it, “FERC is addressing a problem that doesn’texist anymore. They came late to the party.”

The regulators are still trying, however. Given that “we threw alot of stuff out there” in the NOPR and other initiatives, FERCCommissioner Vicky Bailey said she thought the extension request ofthe trade groups was a “very legitimate” one. However, “it [was]our hope to address these issues by the end of the year…to atleast have the comments in by the end of the year,” she told thenearly 400 industry executives and state regulators at theDOE-NARUC conference. “If that’s not possible,” Bailey indicatedthat pushing back the comment deadline might be a “legitimateresponse” due to the scope of the issues. Commissioner Breathittalso said she would seriously consider granting the industry’srequest.

Bailey’s message to the gas industry: “You’ve got to look atthese issues and [you’ve] got to decide what you want, what you’rewilling to live with, what you can’t stand. And tell the Commissionthat in no uncertain terms. Its kind of ‘come to Jesus time.'”

Hoecker Would Involve GISB

Chairman James Hoecker didn’t comment on the extension request,but he did say that he was aware that “all segments of theindustry, as well as their attorneys and consultants, are onoverload right now” as a result of the July NOPR, specifically theauction proposal, and the NOI and other initiatives. He said theCommission offered the proposed changes in a simultaneous fashionrather than “piecemeal or half-heartedly” because the “costs fromthe delay and the confusion of such an approach would be far toogreat.” Given the “unique momentum” coming from competition andconvergence, “we are less able today to attack problems a bite at atime…”

In Pittsburgh, Hoecker urged the gas industry members toundertake a “broad” review of the entire package of reforms thatthe Commission has proposed before “solidifying their judgment.”Moreover, Hoecker suggested that industry set aside the workshopscheduled for Oct. 20th to discuss only the details of how a dailyauction would work, and save any remarks opposing the proposedauction for the written comments that are due at FERC on Nov. 9th.

Hoecker again indicated that the Gas Industry Standards Board(GISB) could play a “key” role in developing a real-timeinteractive auction process – a task that has been criticized bysome GISB members as being “outside the scope” of theirorganization. Producers last week also joined in to protest GISBhaving a role in the creation of an auction process. “The producersdon’t want GISB involved in the auction. They are adamant aboutthis,” said Phil Budzik, director of regulatory affairs for theNatural Gas Supply Association. Producers aren’t too happy with theprogress that GISB has made with the issues on its plate so far, sowhy give the standards-setting organization more, he asked.

Industry reactions to the proposed auction touched on a numberof issues. For Pat Purdy, the CEO of Strategic Energy Ltd., theburning question wasn’t whether an auction process could becreated, but whether it would work and whether it was needed. “Ireally don’t know” if it would work. “We thought that the bidprocess on released capacity was going to work,” and it had “dismalresults,” he said. He also had doubts about the industry’s need foran auction process since more than 80% of the capacity-releasetransactions today are pre-arranged deals. “Probably on somepipelines [there] will be” need, but in other parts of the countrythe market may be working “just fine the way it is.”

Terrence L. McGill, president of Columbia Gulf Transmission, said his company believes the NOPR could create an “artificialbias” in favor of short-term services that “could prove detrimentalto the long-term health and expansion of the industry.” He calledfor the “appropriateness and viability of the auction [to] bebrought into much sharper focus” at the FERC workshop. On a morepositive note, McGill said the auction idea was “further evidence”of the industry’s “move towards the commoditization oftransportation.” Specifically, it is reflective of the move awayfrom “the old public good concept to almost [a] pure bottom-lineorientation.”

Some gas producers at the DOE-NARUC conference speculated thatthe proposed auction and other FERC initiatives could threaten theindustry-wide goal of obtaining a 30-32 Tcf gas market within thenext decade.

“One of my concerns about funneling all the short-term capacitythrough an auction is that it may prevent the development ofgenuine third-party, independent aggregators and brokers…tocompete with current capacity sellers and holders of capacity,”noted one industry executive. Strategic Energy’s Purdy suggestedthat it might be up to state regulators to offer the “rightincentives” to prevent this from happening.

Michigan State University’s Prairie had some further advice forFERC. First, she strongly suggested that any “regulatory model”that it develops aimed at mitigating market power include “theconvergence and consolidation realities” of the industry. “Even ifthere isn’t market concentration today, a few mergers amongpipeline companies…would instantly change the level ofcompetition in both the primary and secondary markets.”

Also, FERC and the state agencies need to take a good look atthemselves. “…[A]s the industry has been transformed, I’m notsure that the staff[s] of the regulatory agencies have beentransformed to go along…to match the restructure.”

Susan Parker, Ellen Beswick

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