After listening to weeks of confusing and often mind-numbing testimony, FERC Chief Administrative Law Judge Curtis Wagner Jr. tossed parties a curve last week when he “strongly encourage[d]” them to reach a money settlement in the high-profile dispute in which El Paso Corp. affiliates are accused of engaging in illegal activity to inflate prices for natural gas in the California market.

Wagner made the recommendation only days after FERC staff counsel found that El Paso Corp. subsidiaries, El Paso Natural Gas and El Paso Merchant Energy Co. (EPME), did in fact possess market power — the ability to maintain prices above competitive levels for a significant period of time — during the summer of 2000, and violated FERC’s marketing affiliate standards that govern the behavior of interstate pipelines and their affiliates.

In a terse order issued late Thursday, Wagner urged the parties to give “serious consideration to disposing of this case by a negotiated settlement,” adding that it “would be in the interest of all” concerned. The pipeline capacity contracts at issue in the case “[have] been terminated for some time now; natural gas prices are down; and possible remedies, should abuse of market power or affiliate standards be found to exist, is not before the chief judge for decision, at least not at this point in time,” he said.

The parties in the case include El Paso pipeline, EPME, Pacific Gas and Electric, Southern California Edison and the California Public Utilities Commission (CPUC), which brought the complaint against the El Paso affiliates.

All sides “will agree that this case is extremely complex and controversial, and will be a very difficult one for the Commission to decide regardless of the initial decision’s findings, and it is almost certain that there will be appeals [of] the Commission’s decision,” Wagner noted. “This means that a final determination in this case is a long time in the future.”

However, “should a substantial monetary settlement be reached now, the people of California will benefit much earlier and perhaps much better than [from] a continuation of this litigation. The people of California deserve a quick end to this litigation and a settlement will provide them with a fair solution now.”

He believes the parties would be “wise to work out a solution to their disputes that they can live with and know the outcome of, rather than take a chance on what a judge, the Commission and the courts may find.” This “admonition…is not to be construed in any way” by parties to mean that a ruling has been made already, Wagner said, adding that he “has not and will not reach a decision” until he has reviewed and digested all briefs and proposed findings filed in the case.

Wagner presided over more than six weeks of hearings this summer exploring allegations that EPME intentionally withheld capacity from the market to drive up delivered prices for gas in southern California beginning in mid-2000, and that El Paso pipeline violated the Commission’s affiliate standards by rigging the bidding process to favor affiliate EMPE during a February 2000 open season. EPME ultimately was awarded 1.22 Bcf/d of capacity on affiliate El Paso pipeline, which was more than one-third of the total capacity on the line. The 15-month contracts for the capacity expired in May (see NGI, June 18).

In the event parties cannot reach a resolution, Wagner has extended the date for parties to submit reply briefs by one week to Sept. 14, given that the “magnitude” of the case is “somewhat overwhelming.” He noted that he still “will make every effort to issue [an] initial decision on or before Oct. 9.”

In another development last week, FERC trial staff — who participated in the summer hearings — filed its “proposed findings of fact and ultimate conclusions” in the case, finding that “El Paso pipeline and El Paso Merchant had market power after May 2000 for at least two months when pipeline capacity constraints created a separate relevant geographic market in Southern California.” During times of such constraints, the Herfindahl-Herschman Index (HHI) “increases to 2,262, which exceeds the 1,800 threshold” deemed appropriate by FERC, the Federal Trade Commission and the Department of Justice for competitive markets, staff counsel said. El Paso’s market share also rises to 45%, which is 10% more than what is considered the safe harbor threshold.

The evidence in this case further “demonstrates that [parent] El Paso Corp. has engaged in affiliate abuse and violated the marketing affiliate standards of conduct,” staff counsel concluded. It pointed to the now-infamous Feb. 7 and 9, 2000 telephone conversations to show that the operating employees of EPME, El Paso pipeline and affiliate Mojave pipeline “were not functioning independently” of each other.

The phone conversations between Harvey Rodman of El Paso pipeline and Robin Cox of EPME took place just days before El Paso pipeline began its open season for 1.22 Bcf/d of firm, California-bound transportation capacity on its system, all of which was awarded to EPME (See NGI, Feb. 21, 2000).

The focus of the recorded telephone conversations was EPME’s “imminent bid on El Paso pipeline’s capacity offering and the discussions provided [EPME] new general information as to how Mojave would change its discounting practices to provide real economic support for a high, total package bid by [affiliate EPME] on all El Paso pipeline’s open season capacity offering,” FERC counsel noted.

During and before the open season, EPME “was privy to new general information about the restructured long-term tiered…discount” on Mojave to Wheeler Ridge, while potential non-affiliate shippers were not, counsel said. Both El Paso pipeline and Mojave “conferred an undue competitive advantage” on EPME by their actions.

The discount “was significantly different from Mojave’s traditional discounting practice,” counsel noted, adding that it “was designed for 16 months, March 1, 2000 through June 2001, to coincide with the 1.2 Bcf/d El Paso pipeline capacity term.” The three companies — El Paso pipeline, Mojave and EPME — “coalesced to restructure [the] Mojave discount rate practice such that the new long-term tiered discount was inextricably linked to the El Paso pipeline open season capacity,” Commission staff counsel concluded.

As a result, EPME’s risk management group “had an undue competitive advantage of factoring the new Mojave discount into formulating a successful bid for all El Paso pipeline’s open season capacity.”

But EPME tells a different story. “Merchant won the capacity because it submitted what proved to be the highest-value bid under [El Paso pipeline’s] publicly posted terms and conditions. Merchant had no foreknowledge of [El Paso pipeline’s] bid criteria,” EPME said in an initial brief submitted to Wagner. Prior to submitting its bid during the Feb. 14, 2000 open season, “Merchant did not communicate with [El Paso pipeline] — either directly or indirectly — what Merchant believed the capacity might be worth.”

Moreover, it denied that it had advance knowledge that affiliate Mojave planned to offer an interruptible discount rate to Wheeler Ridge. “Merchant did not know for certain until after the close of the open season whether Mojave would offer a discount or what the precise terms of any discount would be. But even assuming arguendo that a deal had been struck, Mojave’s posting of the discount was well within the time required by the Commission regulations. Further, knowledge during the open season that Mojave might offer a tiered IT discount to Wheeler Ridge was immaterial to Merchant’s decision to bid for the [El Paso pipeline] capacity and to the value it placed on the capacity — a fact subsequently borne out by Merchant’s use of the discount on only three days during the 15-month term” of its contracts with El Paso pipeline.

EPME also contends that plaintiffs’ evidence that it illegally manipulated delivered gas prices to the southern California market in the latter half of 2000 and early this year is a “jumble of confusion, contradiction, hyperbole and illogic that does not begin to satisfy [the] burden” of proof.

For starters, EPME argues that plaintiffs’ evidence fails to take into consideration two key points — the fact that EPME (like most shippers) was subject to capacity curtailments on affiliate El Paso pipeline at the time, and that it was “hedging” transactions to protect itself against basis differential losses. Both factors undermine the CPUC’s and utilities’ claim that EPME withheld capacity on El Paso pipeline with the intent to manipulate gas prices, EPME said.

“By late June or early July 2000…the pipeline systems delivering gas to California consumers were full, and every shipper, including [EPME], had its nominated volumes of gas curtailed. There was no usable capacity for [EPME] or anyone else to ‘hoard.’ At that point, all capacity on [El Paso pipeline] available to be utilized was in fact being used,” EPME noted.

In addition to being subject to curtailments, EPME said it “hedged” its transactions to protect itself from losing money if the basis differential between the Southwest producing basins and the California border declined. “As a result of hedging, Merchant’s ability to benefit from higher prices was substantially reduced, while its existing incentive to maximize its flows of gas was reinforced,” EPME argued. “Indeed, if Merchant possessed the market power asserted by the CPUC…it would not have needed to hedge against downside price risks because it could raise prices and basis differentials above ‘competitive levels.”

The bottom line is the “price increases in California during 2000 and early 2001 were due to the confluence and tightening of supply/demand factors in both the electric and natural gas sectors, and the constraints that existed on both the pipelines delivering gas to California and on the pipelines operating within California,” EPME said. This “perfect storm” of unusually warm weather, low hydroelectric production, annual demand growth, lack of new generation facilities and a “seriously flawed” electric market “led to record high gas demand in June 2000 and later months — demand was almost 20%, or more than 1 Bcf/d, higher than in previous years.”

The CPUC’s “pretense that these conditions had no impact on California gas prices is contrary to prior Commission orders, the overwhelming weight of the evidence and plain common sense,” the El Paso affiliate noted.

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