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FERC Reverses Policy on Basis Differentials in Negotiated-Rate Deals

In a long-awaited rehearing order on its negotiated-rate policy, FERC last Thursday signaled its willingness to allow interstate natural gas pipelines to enter into negotiated-rate transactions with shippers that reference "basis," or the difference between natural gas price indexes at two market locations.

The Federal Energy Regulatory Commission on rehearing reversed a July 9, 2003 order in which FERC barred the use of "basis differentials" in negotiated-rate agreements between pipelines and their shippers. "The Commission finds that a generic policy against the use of gas basis differentials in negotiated-rate transactions is overly restrictive, given the benefits such pricing mechanisms yield and the fact that there are other less-restrictive means to ensure that the pipelines do not utilize market power to influence the gas commodity," the rehearing order said [PL02-6-001].

In the July 2003 order, the agency amended its 1996 policy statement on negotiated rates to preclude the use of gas basis differentials in such transactions. Rehearing of the order was put on hold at the time because the Commission, which at the time was chaired by Pat Wood, was deadlocked on the issue. Then-Commissioner Joseph Kelliher and Nora Brownell favored negotiated-rate deals that tracked basis differentials, while Wood and Commissioner Suedeen Kelly opposed them.

Wood feared that, by allowing negotiated-rate deals based on basis differentials, pipelines would have an incentive to withhold capacity in an attempt to widen the basis between index points and drive up transportation rates. Pipelines have argued that the basis differential is a good measure of the value of the capacity between two points, and a consistently high basis differential serves as an incentive for construction of more capacity.

"In the Commission's view, the ability of pipelines to [use basis differentials to] manipulate the gas commodity market is tempered by several factors," the rehearing order said. It noted the agency now has several built-in safeguards that "[allow] it to monitor the transactions to determine if the pipeline is withholding capacity in order to increase the gas commodity basis differential." In addition, "subsequent to the modification of the negotiated-rate policy statement [in 2003], Congress has enacted new legislation designed to prohibit manipulation of the gas transportation markets."

Since 2003, "some things have changed, including we have new authority now to address manipulation and it's not just manipulation of gas sales, but gas transportation service...We have new and better enforcement authority. We have better penalty authority," Kelliher said during a press briefing following the regular Commission meeting last Thursday.

Against that backdrop, FERC "looked again at that [issue], which we had been deadlocked on for more than two years, and [found] we weren't deadlocked" anymore, he said. "We issued it [the rehearing order] unanimously -- in large part because of the new legal authority that we have."

Last week's order signals the "willingness of the Commission to look at basis differentials in negotiated rate agreements." It "holds that parties can use basis differentials in negotiated rate agreements," Kelliher told reporters.

Restrictions on basis differential pricing for transportation were part of the fallout from the 2000-2001 California energy crisis and the basis blowout or huge price differential between California delivery points and the rest of the country.

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