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FERC's Capacity Auctions: Going...Going....

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 pre-arranged transactions.

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 Flanders.

"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 flow.

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.

Pricing Options

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 bid.

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 &amp C would be the winning bidders, and would pay precisely what they bid. However, with the second-price option, A, B &amp C would pay $2.10 (the highest losing bid), while under the market-clearing price scenario, A, B &amp 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," Hyde said.

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 in line.

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."

Susan Parker

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