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Industry Still Divided on Pipeline Rules

Industry Still Divided on Pipeline Rules

Based on comments filed by trade associations last week, the natural gas industry is split straight down the middle on most of the major initiatives in the notice of proposed rulemaking (NOPR) and notice of inquiry (NOI) - with the regulated pipelines and LDCs supporting proposals that would lighten FERC's grip on pipeline transportation, and non-regulated producers, marketers and municipal distributors concerned the measures could wreak havoc.

The interstate pipelines and local distribution companies were the only advocates of giving pipelines negotiated authority over terms and conditions of service, and uncapping prices on transactions in the capacity-release portion of the short-term market. The non-regulated sectors feared the measures would enhance the monopoly power of pipelines, of which they are customers. FERC's proposal for mandatory auctioning of short-term capacity was the one major initiative where there was near-uniform agreement - nobody seemed to like it. The closest thing to any kind of support for auctioning came from the producers.

The comments were the culmination of a nine-month effort, which began with the issuance of the NOPR and NOI last July, during which the industry was asked to comprehensively examine a number of second-generation gas issues in an effort to make the market more competitive [RM98-10, RM98-12]. Chairman James Hoecker called it the biggest undertaking since Order 636. The Commission now faces the daunting task of sifting through the flood of comments and proposals to decide how it should reshape the gas industry for the next century.

One of the more interesting proposals last week came from Dynegy. Rather than giving interstate pipelines the authority to negotiate terms and conditions of service, it advocated awarding such authority to pipeline customers - the buyers of recourse services - to allow them to sell or trade components of their recourse services to and among themselves. In short, the Houston-based marketer envisions creating a secondary market for recourse service components that would compete head-to-head with the primary market.

"If there will ever be a hope of competition amongst pipeline services, it must...come from competitors. Dynegy suggests that pipeline customers be allowed to create this competition. Specifically, customers who purchase recourse services should be allowed to trade and/or sell components of services to and among themselves," it told FERC in its comments. "The rights to be traded could include rights to inject or withdraw storage gas during given periods, or a portion or all of a shipper's imbalance tolerance rights."

Dynegy contends that allowing customers, rather than pipelines, to negotiate terms and conditions through the trading of components of recourse service would have "many advantages," such as minimizing the incentive for pipes to "dumb-down" services by stripping out components of services and reselling them to other shippers; limiting the prospect for discrimination since there would be numerous sellers of a particular component of service; forcing pipeline affiliates to use real dollars - rather than what Dynegy refers to as "funny money" - to secure components of a negotiated service; and reducing cost shifting to customers.

In addition to the creation of a secondary market for recourse service components, Dynegy called on FERC to make "generally applicable tariffed services...more flexible as a matter of course." It proposed that a number of "no brainer" changes be incorporated into individual pipeline tariffs to achieve such flexibility. "Once these changes have been made, primary and secondary service offerings will be better positioned to compete against each other, and to mitigate pipeline market power." Only if these services become competitive should FERC then consider lifting the price caps in the short-term market, Dynegy advised.

In contrast, the Interstate Natural Gas Association of America (INGAA), which represents interstate pipelines, and the American Gas Association (AGA), a major LDC group, advocated expanding negotiated authority for pipelines to include terms and conditions. INGAA called these "essential commercial tools," and added it continued to support the AGA-INGAA proposal on this issue that was submitted to FERC in mid-1998. The pipelines insist they need the flexibility to meet the demands of the changing customer mix, which includes more power generators. The AGA said it would go along with giving pipes negotiated authority, but only if a "high-quality recourse service" was available and the Commission's expedited complaint procedures were implemented. Such a recourse rate/service would have to "appropriately reflect cost reductions" and protect recourse shippers against "subsidizing the market-responsive services offered under negotiated-rate policies."

INGAA Supports Seasonal Rates

In an effort to eliminate the bias towards short-term contracting, INGAA also asked the Commission to give pipes the option to implement seasonal and/or term-differentiated rates. "The principle underlying seasonal rates is to align the price of capacity with the usage of capacity, i.e. peak-priced contracts will have a higher price than off-peak contracts. Term-differentiated rates [will] more accurately reflect the relative level of risk that pipelines must face when selling short-term vs. long-term services." Producers cautioned FERC to tread carefully in this area until "fully articulated" proposals have been put on the table. Specifically, Amoco Production, Burlington Resources Oil &amp Gas and Marathon Oil urged against adopting "coercive" term-differentiated rates to force shippers into long-term contracts.

Instead, the three producers asked FERC to mandate their proposal for a three-part incentive rate structure, which would reward efficient pipelines with annual adjustments to their rates of return on equity and permit sharing between pipes and customers of over- and under-recovery of annual revenues received for jurisdictional services. "...[T]his incentive rate model achieves a balanced sharing of risks and rewards...between the pipelines and their customers."

The American Public Gas Association (APGA), a group of municipal gas distributors, and the Natural Gas Supply Association (NGSA), which represents major producers, were on the other side of the fence on the negotiated issue.

"Providing preferential services through negotiated terms and conditions is fundamentally a zero sum game that can only adversely affect captive customers," forcing them to subsidize the services of negotiated customers, the municipals said. Likewise, producers contend such negotiated authority "will inevitably result in preferential contracts, especially...between pipelines and their affiliates, whether they be in the business of producing, processing, gathering, marketing, distribution of gas or the generation of electricity."

Additionally, the municipals insist expanding the negotiated authority of pipelines would "unfairly" devalue released capacity. It "slants the playing field" in favor of a pipeline by enabling it to "sell premium capacity at the same price that [a] captive customer can sell its inferior tariff capacity." In short, it would deny municipals the one "fair opportunity" to market unneeded capacity for which they have paid "unduly high rates" due to FERC's discount adjustment policy, they said in their comments.

Proponents contend pipelines need full negotiated authority to meet the demands of gas-fired power generators and to further grow the market. But critics, such as the APGA, insist the "pell-mell scramble to build gas-fired electric generation" is occurring without this. It says pipelines can satisfy the special needs of generators with flexible tariffs. "A new regime of special and blatantly discriminatory deals is not needed."

On a related issue, Dynegy urged the Commission to reassess Order 497, its pipeline affiliate rule, in light of the increasing convergence between pipelines and electric utilities. First, FERC must require pipeline affiliates to use real corporate dollars - as opposed to "funny money" or what amounts to intra-corporate transfers - when bidding for recourse services or when paying for negotiated services, it said. Secondly, FERC should amend Order 497 such that "proscriptions against undue discrimination, information sharing" would also apply to any Btu-related affiliate, which includes (but isn't limited to) power generation affiliates.

INGAA and AGA supported removing the price caps, but only on the capacity-release component of the short-term market. "This would be a positive step toward creating a truly competitive secondary market," the AGA said. Caps on pipeline sales of short-term firm and interruptible capacity should remain, however, INGAA believes. Both opposed subjecting the uncapped capacity to competitive auctioning, as FERC proposed. "The mandatory auction requirement is especially inappropriate given that pipelines are not seeking to remove the price cap on pipeline sales of short-term firm and interruptible capacity," INGAA noted.

But the APGA called the price-cap removal the "most disturbing aspect" of all FERC's initiatives. Trying to justify market rates in the short-term market is akin to attempting to "stuff a square peg in a round hole. It will not fit." Instead, it said cost-based regulation of both the short-term and long-markets should continue. Producers also opposed abandoning rate caps - unless a showing of competition in the market can be made. If FERC should act otherwise, however, they believe uncapped short-term capacity should be subject to competitive auctioning. And, removal of rate caps should be limited to transactions with a term of one calendar month or less.

The producers' position on mandatory auctions - that they would be "essential" if prices on short-term capacity were uncapped - was the closest thing to support that the Commission received for its controversial proposal. Dynegy, for one, said the goal of the Commission's proposal was "laudable," but added that "the game plan [was] not one that can be successfully executed." Instead, it believes the Commission "should require pipelines to auction off all capacity on a long-term basis, with no reserve price."

Dynegy: Long-Term, Not Daily Auctions

In embracing a daily auction for the short-term market, "the Commission appears to view the gas market as headed full speed to a daily and perhaps hourly market. While there clearly is much more day trading than there was a decade or even just a couple of years ago, this is not the power market," Dynegy reminded FERC. "There is no generator-like precision in wellhead production, and storage, line-pack and tolerable pressure swings can take up the slack when consumption inevitably does not match forecasts. Term transactions - those of 30 days or more - still account for the vast majority of purchases and sales, and will into the future...In the end, there are too many variables to tell exactly where the market is going, or should go. The market is evolving naturally: there is no need to push it via regulation in any particular direction."

As an alternative to a daily auction, Dynegy proposed that willing pipelines be given the go-ahead to release shippers from their current contractual obligations and bid out all capacity on a long-term basis for whatever price the market will bear.

It noted that it espoused auctioning of long-term capacity because it lacked many of the problems that were associated with auctioning on a short-term basis. "Specifically, problems associated with moving gas across the grid disappear because there are not tight time restrictions on when upstream or downstream capacity must be purchased...Pricing volatility is greatly reduced because long-term pricing can be agreed upon upfront...Concerns regarding an increase in transaction costs also go away...Finally, reliability concerns are eliminated."

The AGA said an auction would be a "step in the wrong direction because it would add costs and constraints to the market." Moreover, it argued an auction mechanism would be unnecessary as protection against potential market-power abuse, as FERC envisioned it, "because the secondary market in capacity is robustly competitive." INGAA opposed it on legal grounds, saying a mandatory auction without a reserve price violated the Natural Gas Act and the U.S. Constitution "because it will deny pipelines an opportunity to recover their costs and earn an adequate return." The APGA decried the proposed option mechanism for its complexity.

Pipelines and their customers were split on the issue of straight-fixed variable (SFV) rate design. INGAA urged the Commission to maintain SFV, saying that it promoted "efficient competition and [provided] accurate price signals." However, it added, "where circumstances warrant, pipelines should be permitted to deviate from SFV rate design in their individual rate settlements."

Municipals, on the other hand, believe a move away from SFV rate design to one that would put a greater portion of fixed costs in a pipeline's commodity rate would be the closest thing to a cure-all for the industry. It would provide a solution to such industry concerns as turned-back capacity, the bias against long-term contracts, stunted throughput growth, and stranded costs associated with retail unbundling, they noted.

The APGA said it "wholeheartedly" endorsed a proposal submitted in February by a coalition of LDCs, which called for FERC to mandate a shift away from SFV for interstate pipelines and to adopt a rebuttable presumption whereby 35% of pipeline fixed costs would be recovered through volumetric/commodity rates. Producers indicated they would tolerate only a "limited movement away" from SFV, with a maximum of 10%-15% of the fixed costs to be included in the commodity rate.

Susan Parker

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