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FERC Proposes Negotiated Services, Removal of Price Caps

FERC Proposes Negotiated Services, Removal of Price Caps

Calling it an "important moment" for natural gas regulation, FERC last week proposed lifting the price caps on capacity in the short-term market and allowing pipelines to negotiate the terms and conditions of service subject to certain restrictions. With these and other proposals, which elicited encouraging initial reactions from industry, the Commission formally launched the most comprehensive review of its gas regulations since Order 636.

"We have bitten off quite a lot...," said Chairman James Hoecker in issuing a notice of proposed rulemaking (NOPR) on regulation of short-term transportation services and a notice of inquiry (NOI) on regulation of interstate gas transportation services. He noted that FERC commissioners undertook "both courageous and cautious" steps in the NOPR and NOI, which were the end product of nearly a year of debate.

"...[T]o those who expect from this effort something radical, something one-sided or who fear something irresponsible, you will be sorely disappointed. But if, however, you value innovation and the opportunity for constructive discussion on a whole range of key issues about how to make a good market better, you will be more than pleased I think," Hoecker said. "This proceeding may not be the milestone that 636 was, but it may be something better yet - a new focus on making regulation more market responsive."

The cornerstone of the NOPR proposes the removal of existing price caps on short-term (less than one year) firm, interruptible and capacity-release capacity [RM98-10]. But the proposal was not made willy-nilly, Commissioner William Massey said. "It is coupled with a number of protections, such as a requirement that all available short-term capacity be sold through an auction, a requirement that all short-term services have the same levels of scheduling and nominations purposes to ensure that short-term services will be comparable to one another [and can better compete with pipeline capacity], a requirement that released capacity have the same segmenting rights as pipeline capacity also to ensure comparability, [and] reporting requirements that will allow the Commission to monitor for entities that might try to withhold capacity for a higher price." It also proposes reforms to penalty procedures. All of the proposed protections are aimed at mitigating the potential market power of pipelines and shippers in the short-term market once prices are deregulated.

Specifically, in return for removing the price caps, all short-term capacity - whether it be release capacity or pipeline owned - would be sold through capacity auctions, according to FERC's proposed rulemaking. Under the auction process, pipelines would be required to sell all available short-term capacity on a daily basis at or above the minimum variable cost of the capacity. They wouldn't be permitted to withhold any capacity from shippers.

Producers were both "encouraged" and "intrigued" by the auction proposal. "Quite frankly, we were fearful that it [the Commission] was going to go in the other direction" towards direct brokering, said Philip Budzik, director of federal regulatory affairs at the Natural Gas Supply Association (NGSA). Direct brokering of capacity is "less public and more susceptible to manipulation" than capacity auctions, he noted.

The American Gas Association (AGA), which has supported the removal of price caps, reacted cautiously on this issue. "We have to look at the details of how they've done that because they [FERC] have proposed some new things that haven't been really discussed yet in the industry," such as capacity auctioning, noted Jane Lewis, senior counsel and director.

Commissioner Linda Breathitt noted that while the NOPR provided a "good theoretical framework" for the daily auctioning of capacity, she questioned how and whether it would work under "real world conditions." Her major concerns centered on "how will the intra-day nominations work in a daily auction, how can contingent bids be handled when timing is so critical, how will the features of capacity release - such as the releasing shipper's recall rights - work in conjunction with the auction, and what are the costs and who will pay them." Breathitt also believes the auctions will have to be conducted over the Internet to be effective.

"...[I]t seems that it will be up to the creativity of the industry to resolve the implementation issues that will arise with regard to a daily auction," she said. Commissioner Vicky Bailey concurred, noting that FERC will need "the best thinking of the industry on how such a process can work best, and what the ramifications of an auction process will be on particular pipeline[s] or in specific regions."

The NOPR also proposes that pipelines be allowed to negotiate terms and conditions of service in both the short- and long-term markets, provided they comply with several filing and review requirements. These include: 1) an initial filing enabling shippers to take an active role in determining what constitutes a recourse service; 2) a list from each pipeline of the terms and conditions that will be non-negotiable; 3) a 30-day notice requirement of negotiated deals that may affect other shippers, and a 10-day notice requirement for all other negotiated deals; 4) more detailed filing requirements that will enable shippers to determine whether a negotiated deal will impact their services, or whether they are similarly situated with a shipper receiving a negotiated transaction; 5) periodic reviews of recourse services to ensure their viability; and 6) a requirement that allows negotiation of terms and conditions between a pipeline and its affiliate as long as other similarly situated shippers on its system have been offered the same deal.

Producers, who have been opposed to negotiated services, said they were "encouraged" by this proposal because of the restrictions. "I'm not saying that we're fully on board...but I'm encouraged that the Commission is looking out for the interests of the customer by putting some of these restrictions on negotiated terms and conditions," said NGSA's Budzik.

AGA also seemed to like the Commission's proposal for negotiated services. "I think the designed to allow some flexibility in individual contracting practices, while at the same time [it tries] to ensure that recourse customers are protected and kept whole. I think it is a cautious approach," Lewis said. She noted it incorporates some of the basic tenets of the negotiated plan submitted by AGA and the Interstate Natural Gas Association of America (INGAA) last May.

Massey expressed several concerns about giving pipelines the authority to negotiate their services. For one, "I have not heard a hue and cry from shippers requesting negotiated terms and conditions. Indeed, [it's been] quite the opposite." Before acting on a final rule, "I will need to hear from shippers that can make the case that negotiated terms and conditions will benefit them. After all, they [are] the users of the system."

Moreover, Massey questions whether negotiated terms and conditions will be viable in a short-term market with daily capacity auctions. "Quite candidly, I haven't figured out how we can couple" the two. Should negotiated terms and conditions be limited solely to the long-term transportation market? he asked.

The Commission's proposal "makes a serious attempt at balancing the needs of the short-term market without creating a bias against long-term transactions," Massey noted. Toward that goal, the NOPR proposed removing the five-year matching term for right-of-first refusal. It also takes a close look at how the Commission determines "need" when certificating pipeline projects. Some of the "critical questions" it posed are: "Should the Commission consider more than just precedent agreements or contracts to assess independently the market's need for additional capacity?" and "Should the Commission apply a different standard where certificate applications are supported primarily by contracts with affiliates as opposed to non-affiliates?"

The NOI, on the other hand, is "simply an exploratory journey with respect to pricing issues for the future" in the long-term transportation market, Bailey noted [RM98-12]. "The Commission sets forth several ideas on cost-based and market-based pricing models that could be explored...Some of the ideas have been around the block before, some are new." The NOI, for example, takes a look at rate indexing and incentive rates as possible alternatives to traditional cost-of-service ratemaking, a FERC staff member said. In addition, it asks the gas industry to comment on the future of straight-fixed variable rate design. Comments on the NOI and NOPR are due within 90 days of their publication in the Federal Register.

Susan Parker

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