FERC is sending out mixed signals about its position onauctions. The Commission staff, on the one hand, has been workingsteadily since July towards developing an “efficient andcost-effective” auction structure for the market, yet last week ittold critics that the auction concept might not be the best routeto go. In fact, staff threw down the gauntlet challenging the gasindustry to come up with a better way to sell pipeline capacity inthe short-term market.

“…[A]uctions may not be the right answer. There may be someother alternatives to auctions. So I don’t want you toleave…thinking that all of us [at FERC] are emphatic that this isthe way to go and the only way to go to make a more efficientmarket. It isn’t,” said Kevin Madden, director of the Commission’sOffice of Pipeline Regulation (OPR), at a staff workshop lastTuesday that reviewed different structures for capacity auctions.But with nothing better on the table, the “focus” is on auctions atthis point, he added.

“I wouldn’t be shy if I were you [industry] to tell us why we’rewrong” on this issue, he told gas regulatory officials, executivesand attorneys who packed the Commission’s meeting room to listen tostaff’s auction proposals. “…[B]etween us and you, we don’talways have the right answers. And in many cases, we search for theanswers from you.” The Commission will hold “at least oneadditional conference or workshop or other forum” for staff andindustry to “exchange more specific technical information” aboutthe auction concept, he added.

Madden’s comments sent a somewhat confusing message, saidLorraine Cross, senior vice president of regulatory affairs for theInterstate 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 technicalconferences thereon seems strange.”

In the event the Commission were to agree to auctions, staffstressed that participation by all capacity buyers would not bemandatory. “There seems to be some reason to believe that everybodyhad to participate in the auction,” but that’s not true, saidRichard P. O’Neill, director of FERC’s Office of Economic Policy(OEP). The story would be different, however, for interstatepipelines. “This is not an optional thing for them,” noted LaurelHyde, a senior economist in the OEP.

Moreover, the Commission has not totally ruled out thepossibility that auctioning, if it comes to pass, would apply tolong-term capacity in addition to short-term capacity, O’Neillsaid. “I mean there’s no prohibition on it. The idea is to create abalance and equilibrium between the short- and long-term markets.”

Madden emphasized that the staff workshop was “just thebeginning of a dialogue” on ways to mitigate market power in theevent the price cap on short-term (less than one year) firm,interruptible and capacity-release capacity is removed. FERC raisedthe 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 keyissues on the table,” particularly how to match up supply withpipeline capacity in a daily auction. Patton and others areconcerned that a daily auction would be a logistical nightmare forpipeline buyers, either causing them to be long in supply or longin transportation capacity.

To avoid this, “I think you’d have to identify your supply firstand then arrange [for] transportation,” said Robert Flanders of theOffice of Pipeline Regulation. Then once the transportation deal isconfirmed, 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 tentativesale,” countered Patton, adding that these weren’t practices in thegas industry. “We wouldn’t go buy gas and sell gas without [first]having the capacity. And we wouldn’t buy the capacity withouthaving the gas. We’re putting ourselves at risk,” she said. Toelude these risks, many capacity deals in the industry arepre-arranged transactions.

Greg Lander, president of TransCapacity, recommended that FERCstaff design auctions to take place a day ahead of the nominationprocess rather than on the same day because it would provide anopportunity to create a secondary after-market for buyers that findthemselves long on capacity. “If you could have a secondaryafter-market for what people acquire, then a lot of thesecoordination issues…could be mitigated.”

Chickens v. Eggs

The Commission staff proposed a specific type of auction – thecapacity-item auction – that addressed a key shipper concern aboutbeing able to acquire capacity on multiple paths. Under the auctionprocess, shippers fear that while they might be the winning bidderon upstream capacity, they would lose out on matching downstreamcapacity (or vice versa), which would strand their gas. However,”this bid proposal would ensure that there would be no awardwithout upstream and downstream confirmation,” noted OPR’sFlanders.

“Rather than award capacity to a shipper who finds out theirdownstream arrangement is not there, the confirmation process wouldrun through the steps to make sure that [the] shipper has a lock onthe paths through the segments” it has bid on, he said.

The proposal would require the pipelines to share information onwhether there’s a match in service on the upstream or downstreamportions of their pipe for a specific shipper. Flanders suggestedthat 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 capacitygoes] back to the queue.”

The issue of shippers wanting multiple paths raises the questionof whether the auction rules and procedures should be standardizedacross pipelines, said OEP’s Hyde. “…[I]t’s certainly going to beeasier to bid on a number of pipelines if you see the same ruleseverywhere, and the same timetables…On the other hand, there maybe unique differences across pipelines,” which could preclude thisfrom happening, she noted. OEP’s O’Neill believes standardizationshould be one of the design goals of the auction process.

Contingent bidding, as seen in the capacity-item auctionproposal, may be one possible way to deal with the multiple-pathissue, Hyde acknowledged. “However, the contingent bidding is notfree. It may slow the auction down, and it may also shift risk tothe pipeline who may be left holding the bag or [to] othershippers…” Another possible solution, she noted, is the creationof an integrated regional auction “so that people can acquirecapacity across pipelines.”

Putting the multiple-path issue aside, just the auctioning ofcapacity on a single pipeline will have its share of complexities,Hyde said, adding that FERC and industry will have to considerseveral key design issues: how capacity should be sold, and whetherauctions should be held sequentially or simultaneously. She notedthat auctions could be limited to the sale of one segment at atime. This then would raise the question of whether the auctionsshould be conducted simultaneously – several going on at one time -or whether they should be sequential – one at a time. The upside ofa simultaneous auction is sometimes “there’s a link put in betweenthe auctions, such as you can bid on A and C at the same time,” butthe downside is there’s “a lot of items to watch, and [you] may notend up getting what you want.”

As an alternative to a segment-by-segment auction, Hyde said allthe capacity on a single pipeline could be “thrown into one bigpot,” and bids would be submitted for different pieces of capacity.It would be up to the pipeline and computer systems to analyze “thepossible combinations …that would maximize the revenue,” shenoted. This method “will be more complicated, but it may also turnout to be somewhat more efficient because you can have peoplegetting pieces that are half of what other segments would be.”

Another major issue is whether the auction should be structuredas a daily auction or under some other timeframe, as well as tiedto the nomination process. OEP’s O’Neill believes a daily auctionshould be “integrated into the nomination and scheduling process.”FERC’s proposed capacity-item auction, which would build on theexisting capacity-release mechanism, calls for shippers to combinetheir bid and nomination into a single request the day before gasflow.

A key downside to a daily auction is that time will be of theessence. As a result, it may be necessary to impose single-roundbidding, Hyde noted. “People bid. It’s over. It’s done with. Let’sproceed.” But with a monthly auction, “we’re going to have a lotmore choice…in terms of what can be allowed because we have moretime to play with.”

A major issue, she believes, will be what type of informationshould be posted before and after an auction is completed, and whenit should be posted. “…[W]e think it may be necessary to have[the] minimum bid or reserve price posted pre-auction, especiallywhen affiliated bidders participate. The fear is if …there’s anaffiliate bidding, perhaps only the affiliate might know that[minimum] bid.” Also in cases where an pipeline affiliate isbidding, the Commission believes it may be necessary to post allbids after the auction. In addition, “it may…be necessary to postthe affiliate bidder’s name, even if the other bidders’ names arenot announced,” Hyde said.

“I realize…that some people may have confidentiality concernsabout having their bids announced because those bids may besomewhat detailed” to the point the identity of the bidder could beeasily figured out. In such cases, it may be necessary to use anindependent auctioneer – someone not affiliated with the pipeline.

Pricing Options

FERC and industry furthermore will have to decide whether theywant a first-price auction, a second-price auction or amarket-clearing price auction. The final decision will determinehow much bidders pay for capacity in the end. Under a first-pricescenario, the winning bidder or bidders would pay exactly what theybid. The second-price option would require the winningbidder/bidders to pay the highest losing price. And under themarket-clearing price alternative, they would pay the last winningbid.

Hyde provided an example of how the various pricing optionswould work. Suppose, for example, 100 units of capacity were up forauction, and A bid 20 units at $3.20; B bid 50 units at $3; C bid30 units at $2.50; and D bid 20 units at $2.10. Under thefirst-price alternative, A, B &amp C would be the winning bidders,and would pay precisely what they bid. However, with thesecond-price option, A, B &amp C would pay $2.10 (the highestlosing 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-priceauction because there’s more money in it,” and that bidders wouldfavor a second-price auction, she noted. “However, appearancesaren’t everything. In fact, people are likely to bid more under asecond-price auction because they know they aren’t going to have topay what they bid. They pay according to what other people bid,”Hyde said.

Aside from the many design issues, shippers question how theCommission can ensure that pipelines will put up all theiravailable short-term capacity for auction. Even FERC admits thiscould prove to be a tough nut to crack. “The amount of capacitythat is available on a particular pipeline may vary from a functionof how much compression [it’s] using, how much storage on thesystem they’re willing to bring to bear to augment their capacity.Matters like that are in flux on a steady basis. I think the amountof available capacity may prove to be in the eye of the beholder,”OEP’s O’Neill conceded. Another staff member believes that FERCEnforcement, staff audits, shipper complaints and the historicaldata of pipeline firm and IT shipments will help to keep the pipesin line.

If anything, the workshop revealed that Commission staffmembers, like most others, “are feeling their way forward” on theauction issue, noted TransCapacity’s Lander. “The question is howdo we get what we want, which is a well-functioning capacity marketbut not cause a lot of people to jump off a bridge.”

Susan Parker

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