FERC's Capacity Auctions: Going...Going....
FERC is sending out mixed signals about its position on
auctions. The Commission staff, on the one hand, has been working
steadily since July towards developing an "efficient and
cost-effective" auction structure for the market, yet last week it
told critics that the auction concept might not be the best route
to go. In fact, staff threw down the gauntlet challenging the gas
industry to come up with a better way to sell pipeline capacity in
the short-term market.
"...[A]uctions may not be the right answer. There may be some
other alternatives to auctions. So I don't want you to
leave...thinking that all of us [at FERC] are emphatic that this is
the way to go and the only way to go to make a more efficient
market. It isn't," said Kevin Madden, director of the Commission's
Office of Pipeline Regulation (OPR), at a staff workshop last
Tuesday that reviewed different structures for capacity auctions.
But with nothing better on the table, the "focus" is on auctions at
this point, he added.
"I wouldn't be shy if I were you [industry] to tell us why we're
wrong" on this issue, he told gas regulatory officials, executives
and attorneys who packed the Commission's meeting room to listen to
staff's auction proposals. "...[B]etween us and you, we don't
always have the right answers. And in many cases, we search for the
answers from you." The Commission will hold "at least one
additional conference or workshop or other forum" for staff and
industry to "exchange more specific technical information" about
the auction concept, he added.
Madden's comments sent a somewhat confusing message, said
Lorraine Cross, senior vice president of regulatory affairs for the
Interstate Natural Gas Association of America. "If [the auction's]
not really the direction that the Commission is going to go,
certainly the idea that we're going to have a series of technical
conferences thereon seems strange."
In the event the Commission were to agree to auctions, staff
stressed that participation by all capacity buyers would not be
mandatory. "There seems to be some reason to believe that everybody
had to participate in the auction," but that's not true, said
Richard P. O'Neill, director of FERC's Office of Economic Policy
(OEP). The story would be different, however, for interstate
pipelines. "This is not an optional thing for them," noted Laurel
Hyde, a senior economist in the OEP.
Moreover, the Commission has not totally ruled out the
possibility that auctioning, if it comes to pass, would apply to
long-term capacity in addition to short-term capacity, O'Neill
said. "I mean there's no prohibition on it. The idea is to create a
balance and equilibrium between the short- and long-term markets."
Madden emphasized that the staff workshop was "just the
beginning of a dialogue" on ways to mitigate market power in the
event the price cap on short-term (less than one year) firm,
interruptible and capacity-release capacity is removed. FERC raised
the prospect in a NOPR issued in July.
Kathryn Patton, director and regulatory counsel for Dynegy Inc.,
applauded the FERC staff workshop for "putting some of the key
issues on the table," particularly how to match up supply with
pipeline capacity in a daily auction. Patton and others are
concerned that a daily auction would be a logistical nightmare for
pipeline buyers, either causing them to be long in supply or long
in transportation capacity.
To avoid this, "I think you'd have to identify your supply first
and then arrange [for] transportation," said Robert Flanders of the
Office of Pipeline Regulation. Then once the transportation deal is
confirmed, a buyer could tell its "supplier that that 'tentative'
purchase you had discussed [earlier] was now a real purchase,"
added another staff member.
"...I don't understand the term tentative purchase or tentative
sale," countered Patton, adding that these weren't practices in the
gas industry. "We wouldn't go buy gas and sell gas without [first]
having the capacity. And we wouldn't buy the capacity without
having the gas. We're putting ourselves at risk," she said. To
elude these risks, many capacity deals in the industry are
Greg Lander, president of TransCapacity, recommended that FERC
staff design auctions to take place a day ahead of the nomination
process rather than on the same day because it would provide an
opportunity to create a secondary after-market for buyers that find
themselves long on capacity. "If you could have a secondary
after-market for what people acquire, then a lot of these
coordination issues...could be mitigated."
Chickens v. Eggs
The Commission staff proposed a specific type of auction - the
capacity-item auction - that addressed a key shipper concern about
being able to acquire capacity on multiple paths. Under the auction
process, shippers fear that while they might be the winning bidder
on upstream capacity, they would lose out on matching downstream
capacity (or vice versa), which would strand their gas. However,
"this bid proposal would ensure that there would be no award
without upstream and downstream confirmation," noted OPR's
"Rather than award capacity to a shipper who finds out their
downstream arrangement is not there, the confirmation process would
run through the steps to make sure that [the] shipper has a lock on
the paths through the segments" it has bid on, he said.
The proposal would require the pipelines to share information on
whether there's a match in service on the upstream or downstream
portions of their pipe for a specific shipper. Flanders suggested
that pipelines would exchange their electronic data interchange
(EDI) data sets that provide information on candidate award lists.
"If they get a match, it's an award. If they don't, [the capacity
goes] back to the queue."
The issue of shippers wanting multiple paths raises the question
of whether the auction rules and procedures should be standardized
across pipelines, said OEP's Hyde. "...[I]t's certainly going to be
easier to bid on a number of pipelines if you see the same rules
everywhere, and the same timetables...On the other hand, there may
be unique differences across pipelines," which could preclude this
from happening, she noted. OEP's O'Neill believes standardization
should be one of the design goals of the auction process.
Contingent bidding, as seen in the capacity-item auction
proposal, may be one possible way to deal with the multiple-path
issue, Hyde acknowledged. "However, the contingent bidding is not
free. It may slow the auction down, and it may also shift risk to
the pipeline who may be left holding the bag or [to] other
shippers..." Another possible solution, she noted, is the creation
of an integrated regional auction "so that people can acquire
capacity across pipelines."
Putting the multiple-path issue aside, just the auctioning of
capacity on a single pipeline will have its share of complexities,
Hyde said, adding that FERC and industry will have to consider
several key design issues: how capacity should be sold, and whether
auctions should be held sequentially or simultaneously. She noted
that auctions could be limited to the sale of one segment at a
time. This then would raise the question of whether the auctions
should be conducted simultaneously - several going on at one time -
or whether they should be sequential - one at a time. The upside of
a simultaneous auction is sometimes "there's a link put in between
the auctions, such as you can bid on A and C at the same time," but
the downside is there's "a lot of items to watch, and [you] may not
end up getting what you want."
As an alternative to a segment-by-segment auction, Hyde said all
the capacity on a single pipeline could be "thrown into one big
pot," and bids would be submitted for different pieces of capacity.
It would be up to the pipeline and computer systems to analyze "the
possible combinations ...that would maximize the revenue," she
noted. This method "will be more complicated, but it may also turn
out to be somewhat more efficient because you can have people
getting pieces that are half of what other segments would be."
Another major issue is whether the auction should be structured
as a daily auction or under some other timeframe, as well as tied
to the nomination process. OEP's O'Neill believes a daily auction
should be "integrated into the nomination and scheduling process."
FERC's proposed capacity-item auction, which would build on the
existing capacity-release mechanism, calls for shippers to combine
their bid and nomination into a single request the day before gas
A key downside to a daily auction is that time will be of the
essence. As a result, it may be necessary to impose single-round
bidding, Hyde noted. "People bid. It's over. It's done with. Let's
proceed." But with a monthly auction, "we're going to have a lot
more choice...in terms of what can be allowed because we have more
time to play with."
A major issue, she believes, will be what type of information
should be posted before and after an auction is completed, and when
it should be posted. "...[W]e think it may be necessary to have
[the] minimum bid or reserve price posted pre-auction, especially
when affiliated bidders participate. The fear is if ...there's an
affiliate bidding, perhaps only the affiliate might know that
[minimum] bid." Also in cases where an pipeline affiliate is
bidding, the Commission believes it may be necessary to post all
bids after the auction. In addition, "it may...be necessary to post
the affiliate bidder's name, even if the other bidders' names are
not announced," Hyde said.
"I realize...that some people may have confidentiality concerns
about having their bids announced because those bids may be
somewhat detailed" to the point the identity of the bidder could be
easily figured out. In such cases, it may be necessary to use an
independent auctioneer - someone not affiliated with the pipeline.
FERC and industry furthermore will have to decide whether they
want a first-price auction, a second-price auction or a
market-clearing price auction. The final decision will determine
how much bidders pay for capacity in the end. Under a first-price
scenario, the winning bidder or bidders would pay exactly what they
bid. The second-price option would require the winning
bidder/bidders to pay the highest losing price. And under the
market-clearing price alternative, they would pay the last winning
Hyde provided an example of how the various pricing options
would work. Suppose, for example, 100 units of capacity were up for
auction, and A bid 20 units at $3.20; B bid 50 units at $3; C bid
30 units at $2.50; and D bid 20 units at $2.10. Under the
first-price alternative, A, B & C would be the winning bidders,
and would pay precisely what they bid. However, with the
second-price option, A, B & C would pay $2.10 (the highest
losing bid), while under the market-clearing price scenario, A, B
& C would pay $2.50 (the lowest winning bid).
"It would appear that the pipeline should want the first-price
auction because there's more money in it," and that bidders would
favor a second-price auction, she noted. "However, appearances
aren't everything. In fact, people are likely to bid more under a
second-price auction because they know they aren't going to have to
pay what they bid. They pay according to what other people bid,"
Aside from the many design issues, shippers question how the
Commission can ensure that pipelines will put up all their
available short-term capacity for auction. Even FERC admits this
could prove to be a tough nut to crack. "The amount of capacity
that is available on a particular pipeline may vary from a function
of how much compression [it's] using, how much storage on the
system they're willing to bring to bear to augment their capacity.
Matters like that are in flux on a steady basis. I think the amount
of available capacity may prove to be in the eye of the beholder,"
OEP's O'Neill conceded. Another staff member believes that FERC
Enforcement, staff audits, shipper complaints and the historical
data of pipeline firm and IT shipments will help to keep the pipes
If anything, the workshop revealed that Commission staff
members, like most others, "are feeling their way forward" on the
auction issue, noted TransCapacity's Lander. "The question is how
do we get what we want, which is a well-functioning capacity market
but not cause a lot of people to jump off a bridge."