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FERC Loosens Market Power Test for Storage Projects

The Federal Energy Regulatory Commission (FERC) last Thursday introduced its long-awaited initiative reforming the agency's pricing policies to promote the construction of more natural gas storage sites in the United States -- an action that Chairman Joseph Kelliher said would help improve the operation of the gas markets and reduce price volatility.

The NOPR proposed two methods for prospective developers of gas storage facilities to seek market-based rate authority. Under the first method, storage developers can seek authorization for market-based rates under a new flexible approach that would factor in potential substitutes to storage in the relevant product market when deciding whether market power exists. Those potential substitutes could include available pipeline capacity, supplies from local gas production, LNG and released transportation capacity, which are available to the same customers to be served by the new storage operations [RM05-23, AD04-11].

"Instead of treating gas in storage as a discrete product, the Commission recognizes that storage gas competes with other gas that can be delivered in the same geographic market," Kelliher said. "The goal is clear -- to reduce the volatility of natural gas prices by encouraging expansion of gas storage capacity."

For those in the gas industry who expected a dramatic change in FERC's storage pricing, the notice of proposed rulemaking (NOPR) was something of a letdown, according to a knowledgeable industry source. The critical factor here is just how expansive and liberal will FERC be in considering these substitutes to storage supplies when it determines whether or not an applicant for a new storage project has market power, the industry source noted.

The NOPR still puts the burden on the storage applicant to show that it does not have the ability to exercise significant market power. The initial screen of 1,800 on the Herfindahl-Hirschman Index (HHI), which equates to the existence of about five storage operators (other than the applicant) or substitute suppliers in the relevant product region, will remain the agency's standard for determining the existence of market power. Anything above 1,800 HHI is a signal to FERC that market power may exist, and requires further investigation by the agency. The NOPR also plans to impose a periodic review requirement once every five years on the storage holders of market-based rates; it would apply to new and existing storage facilities.

As for the second method, the Commission proposes to implement rules under the new Natural Gas Act Section 4(f) that would permit market-based rates for new storage capacity that is placed in service after Aug. 8, 2005, the enactment date of the Energy Policy Act. Section 4(f) of the bill authorized market-based rates for new storage projects even if they have market power -- if the Commission determines the project is necessary for the public interest and customers are adequately protected from manipulation.

With respect to the second method, the Commission has requested comments on ways to protect customers, possibly including prohibitions on withholding service, price caps or recourse rates, making it clear that it will be up to the applicant to show how customers will be protected. Projects filed at FERC after the Aug. 8 enactment of the new energy law can bypass the market power test and apply to be considered under Section 4(f). This section would apply to greenfield storage projects, not expansions.

"At this time the Commission is not proposing to adopt any single approach, but asks for comments on what might work and whether the Commission should establish generic safeguards," FERC staff said.

"It sounds like they [FERC] threw up their hands and said 'You [applicant] prove it to us" how a storage project applicant can have market power and still provide sufficient protection to its customers, the industry source said. "FERC may have issued an invitation to a party that nobody will attend," he noted.

Kelliher said that growth in storage capacity "has been static for a number of years," while gas demand, prices and volatility have been increasing.

"This is one of the Commission's responses to a winter of record high gas prices," Kelliher said, noting FERC also has improved its ability to detect market manipulation by entering into an agreement with the Commodity Futures Trading Commission, issuing proposed anti-manipulation rules, and acting quickly on emergency filings following the hurricanes and new infrastructure construction projects to speed the efficient operation of the delivery system.

Commissioner Suedeen Kelly said she was "uneasy about authorizing market-based rates for providers that can exercise market power," finding it "extraordinary" that Congress should single out the storage industry to allow monopoly power. She noted that FERC had only turned down three storage applications for market-based rates recently and two of them were constructed under cost-based rates.

Market watchers point out that the cost of putting in the base or cushion gas in a new storage project is a big deterrent to new storage development with today's high prices.

Comments on the NOPR are due within 60 days of publication in the Federal Register.

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