Whose Idea Was An Auction Anyway?

While technical conference participants hotly debated FERC's natural gas transportation initiatives last week, there appeared to be some areas of agreement - starting with the need for more time to argue.

The current style of pre-arranged capacity release deals also appears to have broad support, as does opposition to requiring expensive new information systems to implement a capacity auction scheme.

The request for extended time came from the four major trade associations that make up the Natural Gas Council (NGC) and two other energy trade groups. They asked FERC for a second extension of the deadline for industry comments on the major notice of proposed rulemaking (NOPR) and notice of inquiry (NOI), moving the current Jan. 22 deadline to April 22. [RM98-10, RM98-12]. The idea is to come up with alternatives to the Commission's proposed short-term capacity auction and at least narrow the differences among the industry segments. As of late Friday, FERC had not acted on the request.

Meanwhile pipelines offered FERC a choice regarding its transportation proposal: either provide an option of seasonal rates or if driven to an auction they will fight to maintain an auction reserve price equal to their maximum rate, thereby defeating the Commission's concept of an auction to establish competitive rates.

Pipelines dropped these alternatives into the mix at the FERC staff's second conference last Tuesday on the auction proposal that's included in the Commission's mega-NOPR.

The Commission has proposed auctioning of short-term capacity on a daily basis as quid pro quo for removing price caps in the secondary market. The conference, rather than resolving any of the issues, only underscored the gas industry's universal opposition to the auction initiative. "It's fraught with a lot of problems, and FERC realizes this," said a producer source.

The latest proposal to set a floor for the reserve price at the cost-of-service rate is intended "to protect the buyer and the market from extraordinary and damaging price swings" in the short-term market, notably during peak periods, according to Lorraine Cross, senior vice president of regulatory affairs for the Interstate Natural Gas Association of America (INGAA). In effect it would allow the auction to set a market price above the maximum lawful price (MLP), but not below it. It also would not allow the pipeline to set a reserve price above the MLP.

As currently proposed, the NOPR denies pipelines the right to set reserve prices in short-term auctions. In effect, it requires them to auction all available capacity to shippers, even if the bids received are below their MLP. From the pipelines' perspective, what FERC is demanding of them is nothing short of "illegal," said Richard Baish, president of El Paso Natural Gas.

The NOPR "presupposes that the Commission has the power under the [Natural] Gas Act to order a pipeline to charge something less than the rate that is on file [in] its tariff. Absent a finding under Section 5 that the rate is no longer J&ampR [just and reasonable], I don't believe the Commission has that power," he told FERC staff. If pipeline revenues are reduced as a result of new Commission policies, Baish is particularly concerned this could unravel El Paso's 1996 rate settlement with its customers. Under that agreement, El Paso agreed to assume 65% of the costs associated with unsubscribed capacity on its system, while customers would shoulder the remaining 35% of the costs.

The Commission is faced with a real dilemma on the reserve-price issue: if it institutes an auction without a reserve price, the pipelines will lose revenues and subsequently will take FERC to court, but if it implements an auction with a reserve price, the producers will take it to court, said the producer source. However, "FERC is less in jeopardy of being overturned by the courts if it goes along with a cost-based seasonal rate proposal" as opposed to the auction, he believes.

The LDCs also cited their disdain for an auction proposal with no reserve price, saying that it would place greater risk on holders of long-term capacity. This is counter to the goal the Commission is trying to achieve as LDCs and state regulators grapple with how to handle expiring pipeline contracts, said William P. Boswell, vice president and general counsel for Peoples Gas and representative for the American Gas Association (AGA). It also could negatively affect the next stage of retail competition at the state level.

Pipes Fear Losses

The proposal for seasonal rates, which would be optional for pipes, is expected to address a major concern of pipelines: that the NOPR's bias towards the short-term market over the long-term market would result in the underrecovery of costs for them. "Under the seasonal pricing model, the pipeline's projected annual revenues would not change [be reduced]" in the event of capacity auctioning, said John W. Somerhalder, president of Tennessee Gas Pipeline. Tariff rates would be set such that pipelines would be able to recover more fixed costs in the per-unit charge during peak winter periods than in off-peak periods, he explained.

Shippers reacted cautiously to the pipelines' two proposals. "I saw no attempt made by the pipelines other than to push all of the risk on to the shippers," said Jeffrey A. Holligan of Amoco Production at the day-long conference.

Given that the pipes' reserve-price proposal, which would allow short-term auction prices to go above but not below the maximum rate, could mean excess revenue for pipelines, it begs the question of what would happen to that excess revenue, said Washington attorney Kathy Edwards. Would pipelines keep the excess as profit or flow it back to shippers? the producer attorney asked.

Also since seasonal rates wouldn't be mandatory, "one of the things that I'd want to look to is whether the price signals of the generation market and other aspects of the energy market would be distorted as a result of having seasonality in one pipeline," but not in another, said Tom Brill of Sempra Energy.

"Everybody appears to be saying this [seasonal ratemaking] is going to be the solution to the problem. I think what we should be really looking at is other rate designs other than SFV, perhaps moving to a volumetric rate [to encourage] the pipelines to maximize the throughput in their systems," said Kathryn Patton, director and regulatory counsel for Dynegy Inc.

Another key issue tackled by industry representatives was pre-arranged deals. Kevin Madden, director of FERC's Office of Pipeline Regulation (OPR), questioned whether excluding capacity associated with pre-arranged and bilateral transactions from auctions would, in fact, render auctions meaningless. Most agreed it wouldn't.

Auction for IT

"The capacity that I'd think you'd find remaining in the auction bloc would be the pipelines' IT, which there's still a significant amount of...that [that] trades. And I think you'll find there'll be some secondary [capacity] in there on a voluntary basis," said Denise C. Goulet of the Pennsylvania Office of Consumer Advocate. "We're not precluding the prospect of secondary capacity trading in an auction process, [we're] only saying that it shouldn't be mandatory," she noted.

Goulet's group believes FERC should require pipeline interruptible and short-term capacity to be traded in auctions, but not released capacity. "...[W]e think release capacity markets are...robustly competitive currently. The vast majority of the release transactions occur at well below the maximum tariff rate for the capacity that's traded. We are aware of no complaints of market-power abuses in this process. In addition, there is no incentive for the primary participants in the secondary capacity market [the LDCs] to withhold capacity from the marketplace. So the primary premise for mandating an auction just isn't there with respect to the secondary market," she said.

"Forcing secondary capacity into a mandatory auction without the ability to do pre-arranged deals, without the ability to have recall rights will not only result in fewer capacity options being traded because the LDCs just cannot afford to forego the right to be able to recall capacity, but you may also find that there are fewer revenue offsets" for residential customers, Goulet said.

Some conference participants were particularly concerned FERC changes might unravel the state unbundling programs that have been based on current rules. Others believe FERC has it all backwards - it should work on long-term capacity issues first and then possibly tackle an auction.

Dynegy's Patton thinks it might be best to "relegate" the issues raised in the NOPR, especially the auction proposal, back to NOI status. "Quite frankly, the NOPR has more questions than answers...."

Susan Parker

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