Industry Still Divided on Pipeline Rules
Based on comments filed by trade associations last week, the
natural gas industry is split straight down the middle on most of
the major initiatives in the notice of proposed rulemaking (NOPR)
and notice of inquiry (NOI) - with the regulated pipelines and LDCs
supporting proposals that would lighten FERC's grip on pipeline
transportation, and non-regulated producers, marketers and
municipal distributors concerned the measures could wreak havoc.
The interstate pipelines and local distribution companies were
the only advocates of giving pipelines negotiated authority over
terms and conditions of service, and uncapping prices on
transactions in the capacity-release portion of the short-term
market. The non-regulated sectors feared the measures would enhance
the monopoly power of pipelines, of which they are customers.
FERC's proposal for mandatory auctioning of short-term capacity was
the one major initiative where there was near-uniform agreement -
nobody seemed to like it. The closest thing to any kind of support
for auctioning came from the producers.
The comments were the culmination of a nine-month effort, which
began with the issuance of the NOPR and NOI last July, during which
the industry was asked to comprehensively examine a number of
second-generation gas issues in an effort to make the market more
competitive [RM98-10, RM98-12]. Chairman James Hoecker called it
the biggest undertaking since Order 636. The Commission now faces
the daunting task of sifting through the flood of comments and
proposals to decide how it should reshape the gas industry for the
One of the more interesting proposals last week came from
Dynegy. Rather than giving interstate pipelines the authority to
negotiate terms and conditions of service, it advocated awarding
such authority to pipeline customers - the buyers of recourse
services - to allow them to sell or trade components of their
recourse services to and among themselves. In short, the
Houston-based marketer envisions creating a secondary market for
recourse service components that would compete head-to-head with
the primary market.
"If there will ever be a hope of competition amongst pipeline
services, it must...come from competitors. Dynegy suggests that
pipeline customers be allowed to create this competition.
Specifically, customers who purchase recourse services should be
allowed to trade and/or sell components of services to and among
themselves," it told FERC in its comments. "The rights to be traded
could include rights to inject or withdraw storage gas during given
periods, or a portion or all of a shipper's imbalance tolerance
Dynegy contends that allowing customers, rather than pipelines,
to negotiate terms and conditions through the trading of components
of recourse service would have "many advantages," such as
minimizing the incentive for pipes to "dumb-down" services by
stripping out components of services and reselling them to other
shippers; limiting the prospect for discrimination since there
would be numerous sellers of a particular component of service;
forcing pipeline affiliates to use real dollars - rather than what
Dynegy refers to as "funny money" - to secure components of a
negotiated service; and reducing cost shifting to customers.
In addition to the creation of a secondary market for recourse
service components, Dynegy called on FERC to make "generally
applicable tariffed services...more flexible as a matter of
course." It proposed that a number of "no brainer" changes be
incorporated into individual pipeline tariffs to achieve such
flexibility. "Once these changes have been made, primary and
secondary service offerings will be better positioned to compete
against each other, and to mitigate pipeline market power." Only if
these services become competitive should FERC then consider lifting
the price caps in the short-term market, Dynegy advised.
In contrast, the Interstate Natural Gas Association of America
(INGAA), which represents interstate pipelines, and the American
Gas Association (AGA), a major LDC group, advocated expanding
negotiated authority for pipelines to include terms and conditions.
INGAA called these "essential commercial tools," and added it
continued to support the AGA-INGAA proposal on this issue that was
submitted to FERC in mid-1998. The pipelines insist they need the
flexibility to meet the demands of the changing customer mix, which
includes more power generators. The AGA said it would go along with
giving pipes negotiated authority, but only if a "high-quality
recourse service" was available and the Commission's expedited
complaint procedures were implemented. Such a recourse rate/service
would have to "appropriately reflect cost reductions" and protect
recourse shippers against "subsidizing the market-responsive
services offered under negotiated-rate policies."
INGAA Supports Seasonal Rates
In an effort to eliminate the bias towards short-term
contracting, INGAA also asked the Commission to give pipes the
option to implement seasonal and/or term-differentiated rates. "The
principle underlying seasonal rates is to align the price of
capacity with the usage of capacity, i.e. peak-priced contracts
will have a higher price than off-peak contracts.
Term-differentiated rates [will] more accurately reflect the
relative level of risk that pipelines must face when selling
short-term vs. long-term services." Producers cautioned FERC to
tread carefully in this area until "fully articulated" proposals
have been put on the table. Specifically, Amoco Production,
Burlington Resources Oil & Gas and Marathon Oil urged against
adopting "coercive" term-differentiated rates to force shippers
into long-term contracts.
Instead, the three producers asked FERC to mandate their
proposal for a three-part incentive rate structure, which would
reward efficient pipelines with annual adjustments to their rates
of return on equity and permit sharing between pipes and customers
of over- and under-recovery of annual revenues received for
jurisdictional services. "...[T]his incentive rate model achieves a
balanced sharing of risks and rewards...between the pipelines and
The American Public Gas Association (APGA), a group of municipal
gas distributors, and the Natural Gas Supply Association (NGSA),
which represents major producers, were on the other side of the
fence on the negotiated issue.
"Providing preferential services through negotiated terms and
conditions is fundamentally a zero sum game that can only adversely
affect captive customers," forcing them to subsidize the services
of negotiated customers, the municipals said. Likewise, producers
contend such negotiated authority "will inevitably result in
preferential contracts, especially...between pipelines and their
affiliates, whether they be in the business of producing,
processing, gathering, marketing, distribution of gas or the
generation of electricity."
Additionally, the municipals insist expanding the negotiated
authority of pipelines would "unfairly" devalue released capacity.
It "slants the playing field" in favor of a pipeline by enabling it
to "sell premium capacity at the same price that [a] captive
customer can sell its inferior tariff capacity." In short, it would
deny municipals the one "fair opportunity" to market unneeded
capacity for which they have paid "unduly high rates" due to FERC's
discount adjustment policy, they said in their comments.
Proponents contend pipelines need full negotiated authority to
meet the demands of gas-fired power generators and to further grow
the market. But critics, such as the APGA, insist the "pell-mell
scramble to build gas-fired electric generation" is occurring
without this. It says pipelines can satisfy the special needs of
generators with flexible tariffs. "A new regime of special and
blatantly discriminatory deals is not needed."
On a related issue, Dynegy urged the Commission to reassess
Order 497, its pipeline affiliate rule, in light of the increasing
convergence between pipelines and electric utilities. First, FERC
must require pipeline affiliates to use real corporate dollars - as
opposed to "funny money" or what amounts to intra-corporate
transfers - when bidding for recourse services or when paying for
negotiated services, it said. Secondly, FERC should amend Order 497
such that "proscriptions against undue discrimination, information
sharing" would also apply to any Btu-related affiliate, which
includes (but isn't limited to) power generation affiliates.
INGAA and AGA supported removing the price caps, but only on the
capacity-release component of the short-term market. "This would be
a positive step toward creating a truly competitive secondary
market," the AGA said. Caps on pipeline sales of short-term firm
and interruptible capacity should remain, however, INGAA believes.
Both opposed subjecting the uncapped capacity to competitive
auctioning, as FERC proposed. "The mandatory auction requirement is
especially inappropriate given that pipelines are not seeking to
remove the price cap on pipeline sales of short-term firm and
interruptible capacity," INGAA noted.
But the APGA called the price-cap removal the "most disturbing
aspect" of all FERC's initiatives. Trying to justify market rates
in the short-term market is akin to attempting to "stuff a square
peg in a round hole. It will not fit." Instead, it said cost-based
regulation of both the short-term and long-markets should continue.
Producers also opposed abandoning rate caps - unless a showing of
competition in the market can be made. If FERC should act
otherwise, however, they believe uncapped short-term capacity
should be subject to competitive auctioning. And, removal of rate
caps should be limited to transactions with a term of one calendar
month or less.
The producers' position on mandatory auctions - that they would
be "essential" if prices on short-term capacity were uncapped - was
the closest thing to support that the Commission received for its
controversial proposal. Dynegy, for one, said the goal of the
Commission's proposal was "laudable," but added that "the game plan
[was] not one that can be successfully executed." Instead, it
believes the Commission "should require pipelines to auction off
all capacity on a long-term basis, with no reserve price."
Dynegy: Long-Term, Not Daily Auctions
In embracing a daily auction for the short-term market, "the
Commission appears to view the gas market as headed full speed to a
daily and perhaps hourly market. While there clearly is much more
day trading than there was a decade or even just a couple of years
ago, this is not the power market," Dynegy reminded FERC. "There is
no generator-like precision in wellhead production, and storage,
line-pack and tolerable pressure swings can take up the slack when
consumption inevitably does not match forecasts. Term transactions
- those of 30 days or more - still account for the vast majority of
purchases and sales, and will into the future...In the end, there
are too many variables to tell exactly where the market is going,
or should go. The market is evolving naturally: there is no need to
push it via regulation in any particular direction."
As an alternative to a daily auction, Dynegy proposed that
willing pipelines be given the go-ahead to release shippers from
their current contractual obligations and bid out all capacity on a
long-term basis for whatever price the market will bear.
It noted that it espoused auctioning of long-term capacity
because it lacked many of the problems that were associated with
auctioning on a short-term basis. "Specifically, problems
associated with moving gas across the grid disappear because there
are not tight time restrictions on when upstream or downstream
capacity must be purchased...Pricing volatility is greatly reduced
because long-term pricing can be agreed upon upfront...Concerns
regarding an increase in transaction costs also go away...Finally,
reliability concerns are eliminated."
The AGA said an auction would be a "step in the wrong direction
because it would add costs and constraints to the market."
Moreover, it argued an auction mechanism would be unnecessary as
protection against potential market-power abuse, as FERC envisioned
it, "because the secondary market in capacity is robustly
competitive." INGAA opposed it on legal grounds, saying a mandatory
auction without a reserve price violated the Natural Gas Act and
the U.S. Constitution "because it will deny pipelines an
opportunity to recover their costs and earn an adequate return."
The APGA decried the proposed option mechanism for its complexity.
Pipelines and their customers were split on the issue of
straight-fixed variable (SFV) rate design. INGAA urged the
Commission to maintain SFV, saying that it promoted "efficient
competition and [provided] accurate price signals." However, it
added, "where circumstances warrant, pipelines should be permitted
to deviate from SFV rate design in their individual rate
Municipals, on the other hand, believe a move away from SFV rate
design to one that would put a greater portion of fixed costs in a
pipeline's commodity rate would be the closest thing to a cure-all
for the industry. It would provide a solution to such industry
concerns as turned-back capacity, the bias against long-term
contracts, stunted throughput growth, and stranded costs associated
with retail unbundling, they noted.
The APGA said it "wholeheartedly" endorsed a proposal submitted
in February by a coalition of LDCs, which called for FERC to
mandate a shift away from SFV for interstate pipelines and to adopt
a rebuttable presumption whereby 35% of pipeline fixed costs would
be recovered through volumetric/commodity rates. Producers
indicated they would tolerate only a "limited movement away" from
SFV, with a maximum of 10%-15% of the fixed costs to be included in
the commodity rate.