El Paso Disputes Market Power Charges, Cites Hedging Losses

Battling on several fronts, El Paso Corp. affiliates last week defended against charges from California interests that it used market power to manipulate the market, claiming opposing testimony was rigged, and its own hedging losses argue against any attempt to withhold pipeline capacity from the market.

El Paso and Reliant Energy (see separate report), appear to be bearing the brunt of recent price-gouging and market manipulation accusations from California politicians, regulators, and utilities, which have been attempting to lay the blame for sky-high energy prices in the state on outside energy providers.

El Paso claims it was set up by California Assembly members to take the blame for high gas prices in the state. It said recent hearings before a subcommittee were a "sham," and that it was "predetermined" that El Paso would be accused on wrongdoing in a report approved by the subcommittee majority early last week.

The company publicly contested the results of the majority report (approved 3-2) of the California Assembly Subcommittee on Energy Oversight, which says El Paso drove up gas prices by withholding pipeline capacity from the market, focusing on the same year-old 1.2 Bcf/d capacity contract between El Paso's pipeline and marketing affiliates that also is the subject of an on-going FERC hearing before an administrative law judge.

Contrary to the majority report, however, are the conclusions of a report prepared for the two Republican members of the five-member subcommittee. That document said the hearings "produced no conclusive evidence" of price manipulation.

Although the majority report has not been made public, "it is clear, based on accounts of the report and recently uncovered documents, that the subcommittee hearing was a sham," El Paso said in a statement.

El Paso released to the public documents containing e-mail correspondence between staff members of the subcommittee and members of the Brattle Group, a Cambridge, MA, paid consulting firm for Southern California Edison. The Brattle Group's report also is being used at the hearings this week before FERC's Chief Administrative Law Judge Curtis Wagner Jr. The report accuses El Paso of costing Californians an additional $3.7 billion in gas costs over the past year.

The correspondence El Paso released reveals a close relationship between the consulting firm and the subcommittee staff. For example, a staff member said to Brattle Group's Matthew O'Loughlin, "I can't thank you and Paul enough for your testimony. It was beyond expectations, the members were highly impressed. The chairman asked me if you guys could stay and help us with a second day. We could have used it."

El Paso said the communication reveals that the subcommittee majority's conclusions were "pre-determined to blame El Paso for California's failed energy policies." The subcommittee majority was working "hand-in-hand with, and relying on, SCE's consultant, the Brattle Group, in their so-called analysis," El Paso said. "That the subcommittee majority never intended to conduct an objective investigation is clear... [R]ather than write an objective report based on the testimony, the staff went on to ask SCE's consultant for help in 'rebutting' El Paso's testimony."

"It is obvious that the subcommittee hearings were a charade that was orchestrated from the beginning. Final conclusions were drawn before we had an opportunity to testify and then the final report was leaked to the press instead of provided to us, so that we would not have an opportunity to react," said Norma Dunn, senior vice president of Communications and Government Affairs for El Paso.

In the FERC hearing in Washington El Paso's attorneys charged the California Public Utilities Commission's testimony also was influenced by Brattle Group study, which has been sponsored in the hearing by SoCal Edison.

Testimony filed by El Paso Merchant Energy in the FERC hearing revealed the company's merchant arm racked up a total of $691 million in hedging losses in the first 13 months of its contract for 1.2 Bcf/d of capacity on affiliate El Paso Natural Gas. El Paso witnesses claimed the hedging losses made it imperative for the trading arm to flow as much gas as it could to California to help make up those losses.

The loss figures due to overhedging, including $262 million from the start of the contract March 1, 2000 through the end of the year and $429 million in the first quarter of this year, were part of the prepared testimony of Ralph Eads, president of El Paso Merchant, which had originally been filed in the case under protective cover. The protected material designation was removed last Tuesday and the losses were made part of the public record. El Paso Merchant, defending against charges that it had market power and used it to hike California border prices, argued that taking the large hedge position was not the typical strategy of a market participant which believed it could control the market and run up prices.

Eads said it was a strategy based on the fact that the capacity historically had been underutilized. Also he noted that the Block I, II and III capacity under the 18- month contract (which expires at the end of this month) included service limitations and restrictions that effectively restricted full capacity "Merchant recognized that throughput was low at the PG&E-Topock and SoCal-Ehrenberg delivery points during many periods in the past. What Merchant needed to hedge against was the possibility that basis differentials to the California border would fall, which would mean that demand was weak and the capacity would continue to be underutilized."

Historically, Eads said, load factors had been about 50% and the basis spread between the San Juan Basin and California had ranged from 20 cents to 50 cents/MMBtu. While it hoped to increase throughput, "Merchant expected neither the magnitude nor the duration of the high gas prices and increased basis differentials experienced at the California border over the past 11 months. Thus, El Paso's losses on its hedging transactions have been much higher than it expected."

Contrary to charges by the CPUC that it had restricted the use of its capacity, Eads said the way to recoup some of those losses was to flow gas. Because of the restrictions on receipt and delivery points and other factors it was not possible to use all the capacity all of the time. El Paso Merchant never considered purposely withholding capacity to affect prices "because it was obvious to Merchant...that Merchant could not affect prices at border by withholding capacity because of the sheer size of the market and large number of participants." Especially with the basis differentials above maximum pipeline tariff rates, others would readily pick up any unused capacity on an interruptible basis, Eads said.

Another controversial document, filed by the CPUC and remaining under protective seal --- available only to parties in the case --- got an airing of sorts in the hearing Tuesday when Judge Wagner commented that it "certainly has statements in it that could lead one to believe there was an abuse" of market power. The New York Times has reported that in a Feb. 14, 2000 memo it had obtained, El Paso Merchant said that its contracted capacity would give it more control of the market. Attorneys would not comment on the contents of the document. However, El Paso Merchant attorney Bill Scherman said the judge's comment came before El Paso had a chance to testify on the subject, indicating that testimony would rebut the market power conclusion.

Scherman and an attorney for the pipeline spent most of the first two days of the hearing tearing apart the prepared testimony of the CPUC, which brought the complaint against the conglomerate (RP00-241). Under cross examination Sandra Rovetti, the author of the CPUC's complaint, admitted that in attributing the high basis differentials and corresponding border prices to El Paso, she did not consider other factors such as capacity released or available on other pipelines, receipt or delivery point restraints on Merchant's capacity, the lack of takeaway capacity at the border and the fact that even primary shippers experienced cutbacks in their border deliveries or receipts out of the San Juan Basin. Nor in her evaluation of prices did she consider what Scherman called "highly relevant" items, such as the low storage levels in the West and the slow build up of storage, increases in demand for power generation, or high oil prices.

The CPUC testimony focused on the fact that the magnitude of the basis differential from the producing areas to the border steadily increased after El Paso Merchant took over the capacity. The analysis covered the period from March 1, 2000 when El Paso Merchant took over the capacity until Aug. 18, the day before an explosion on the El Paso pipeline. Rovetti's testimony discussed how El Paso Merchant could have made a profit by offering short term released capacity at unattractive rates and conditions in order to discourage other marketers from bidding on it. The CPUC had objected early on to allotting the capacity to the pipeline's affiliate, saying that would discourage El Paso Natural Gas from selling interruptible capacity in competition with its merchant trading arm See NGI, Feb. 21, 2000). The large block of capacity, about one/third of El Paso's capacity to California, has been the center of controversy since 1997, when it was first leased by Dynegy for a two-year term.

If the charges are substantiated in the FERC hearing, Judge Wagner could order the company to refund any money it earned due to price or supply manipulation. The details of the charges are well known at this point. Critics alleged that El Paso Merchant Energy Gas LP and El Paso Merchant Energy Co. received inside information on a discount transportation rate that enabled them to end up the big winners in an open season for the capacity in February of last year.

But in an order on the complaint in March, FERC found "no merit in the allegations" that the bidding awarding the capacity was rigged. Moreover, it said there was no evidence that El Paso violated its standards of conduct. However, the Commission did not dismiss charges that El Paso had market power and engaged in market and price manipulation, setting those issues for hearing and ordered the judge to provide an initial decision within 60 days (see NGI, April 2).

FERC staff submitted testimony the previous week, saying El Paso probably had unacceptable market power in the Southern California gas market last year when pipeline capacity constraints existed. (see NGI, May 14).

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