Can you trust a marketer with all of your regulated assets? It’sa question many LDCs are asking themselves these days asderergulation and competition are stranding more and more supplycontracts, upstream transportation and storage. But there’s no easyanswer, according to several panelists speaking at GasMart/Power’99 in Dallas yesterday.

Asset optimization clearly is not a one-size-fits-all solution,and outsourcing may not be the right strategy for every unbundlingdistributor. “Why do it? One reason would be to increase earnings,make more money,” Consolidated Edison’s Paul Olmsted noted. Butthat is by no means a sure thing.

“If you fully outsource you could get rid of many of the peoplethat performed that function and cut your costs a little bit.Smaller companies may not have the staff resources on hand orreally the scope of assets to really be able to effectively sellinto the marketplace and get the best return.”

That was part of the reason Providence Gas signed a total assetmanagement contract with Duke Energy in September 1997. “The keyissue that we were faced with was the issue of price volatility,”said Tim Lyons, vice president of marketing and regulatory affairsfor ProvGas. “We had over the prior three years experiencedtremendous volatility. We had a [gas cost adjustment] mechanismwhere basically the price we were charging customers was the Nymexprice. So as the Nymex went shooting up so did our prices, and asthe Nymex went crashing down so did our prices. And it was thisvolatility that created a lot of problems for our customers and ourregulators. We tried a couple of things. We tried a pilot hedgingprogram to mitigate some of that, but we weren’t that successful.”

Providence Gas has a net income of about $80 million but its gascosts are about $100 million “so even a 10% slip up in any of theserisks could wipe out our earnings for an entire year so it’s verycritical for us to manage those risks.”

There were other reasons as well. ProvGas needed some extrarevenue for old gas main replacement and an expansion into neweconomically attractive areas. Meanwhile, regulators andlegislators dealing with electric restructuring were calling for arate cut for both electric and gas customers.

What the LDC came up with was a condensed formula for all of itssupply delivery needs that would provide a reduced and fixed ratefor its customers in addition to the revenues required for itssystem upgrade. Lyons described it as Nymex plus X, with Xrepresenting costs of delivery in addition to the pure commodity.ProvGas then held an auction and granted the winning bidder, DukeEnergy, an unprecedented deal that allowed total control overProvGas’ assets in return for a promised savings of $75 millionover three years. It has saved customers 4% off their bills and,according to Lyons, has encouraged competition because marketerslike having a fixed regulated rate to underbid in the retailmarkets. ProvGas has 14 marketers participating in its unbundlingprogram, and customer savings have averaged 5-20%.

Other LDCs have jumped on the outsourcing bandwagon recently,including Brooklyn Union, which signed a $500 million, one-year gasmanagement contract with Enron, who promised savings of more than$10 million, 80% of which would go to ratepayers. And Sempra EnergyTrading agreed in January to manage the supply and delivery of gasto serve Southern Connecticut Gas Co.’s 158,000 customers,including 37 Bcf of supply, 4 Bcf of storage capacity and 162MMcf/d transportation capacity.

But Olmstead issued a warning to LDCs who are thinking aboutsigning on with a marketer. “You’re entrusting the delivery of gasto another company who does not have the same interest inmaintaining that reliable supply that we do… We’re the guys withthe matches. If the gas doesn’t come to the citygate, we’re theguys who have to re-light all the pilot lights, and I can assureyou that re-lighting a million pilot lights in New York City wouldbe a horrendous undertaking.”

Olmsted pointed out that none of these new outsourcing deals”have been really tested by a really cold winter like we had in1993-94 or an exceptionally high-priced winter like a couple ofyears after that. We’re all praying for a return to normal weather,but if it gets really cold we just don’t know how things willwork.”

Another problem is that total asset optimization it’s “prettymuch irrevocable,” he noted. “Once you go whole hog, you can’t goback because you’re going to disperse the folks who have been doingit, and you’re going to lose the expertise.”

But the deciding factor, according to Olmsted, is the risk ofmaking less money. “If it’s an all-or-nothing thing, you have a lotto lose.”

ConEd has done some partial outsourcing, sharing assets withmarketers and splitting the results. But many times the benefits ofthese deals aren’t worth the trouble, he said.

“In other cases what we’ve found is the activity of the marketerhas not actually increased the value to us. It’s possible that amarketer with national scale is putting our asset into this bigpicture, and if they do that, theoretically they can generate morevalue than I can. The problem has come after that in many cases,”with marketer transaction fees and revenue sharing.

“I would never say never about doing the whole thing because theworld could change and we might find that someone does give us morevalue than we can generate on our own. But when we look at ouroverall strategy for maximizing our bottom line and minimizing thecost of gas to our customers we look at outsourcing as one of manytools” and not the only solution for the changing needs of the LDC.

©Copyright 1999 Intelligence Press Inc. All rights reserved. Thepreceding news report may not be republished or redistributed, inwhole or in part, in any form, without prior written consent ofIntelligence Press, Inc.