Based on comments filed by trade associations last week, thenatural gas industry is split straight down the middle on most ofthe major initiatives in the notice of proposed rulemaking (NOPR)and notice of inquiry (NOI) – with the regulated pipelines and LDCssupporting proposals that would lighten FERC’s grip on pipelinetransportation, and non-regulated producers, marketers andmunicipal distributors concerned the measures could wreak havoc.

The interstate pipelines and local distribution companies werethe only advocates of giving pipelines negotiated authority overterms and conditions of service, and uncapping prices ontransactions in the capacity-release portion of the short-termmarket. The non-regulated sectors feared the measures would enhancethe monopoly power of pipelines, of which they are customers.FERC’s proposal for mandatory auctioning of short-term capacity wasthe one major initiative where there was near-uniform agreement -nobody seemed to like it. The closest thing to any kind of supportfor auctioning came from the producers.

The comments were the culmination of a nine-month effort, whichbegan with the issuance of the NOPR and NOI last July, during whichthe industry was asked to comprehensively examine a number ofsecond-generation gas issues in an effort to make the market morecompetitive [RM98-10, RM98-12]. Chairman James Hoecker called itthe biggest undertaking since Order 636. The Commission now facesthe daunting task of sifting through the flood of comments andproposals to decide how it should reshape the gas industry for thenext century.

One of the more interesting proposals last week came fromDynegy. Rather than giving interstate pipelines the authority tonegotiate terms and conditions of service, it advocated awardingsuch authority to pipeline customers – the buyers of recourseservices – to allow them to sell or trade components of theirrecourse services to and among themselves. In short, theHouston-based marketer envisions creating a secondary market forrecourse service components that would compete head-to-head withthe primary market.

“If there will ever be a hope of competition amongst pipelineservices, it must…come from competitors. Dynegy suggests thatpipeline customers be allowed to create this competition.Specifically, customers who purchase recourse services should beallowed to trade and/or sell components of services to and amongthemselves,” it told FERC in its comments. “The rights to be tradedcould include rights to inject or withdraw storage gas during givenperiods, or a portion or all of a shipper’s imbalance tolerancerights.”

Dynegy contends that allowing customers, rather than pipelines,to negotiate terms and conditions through the trading of componentsof recourse service would have “many advantages,” such asminimizing the incentive for pipes to “dumb-down” services bystripping out components of services and reselling them to othershippers; limiting the prospect for discrimination since therewould be numerous sellers of a particular component of service;forcing pipeline affiliates to use real dollars – rather than whatDynegy refers to as “funny money” – to secure components of anegotiated service; and reducing cost shifting to customers.

In addition to the creation of a secondary market for recourseservice components, Dynegy called on FERC to make “generallyapplicable tariffed services…more flexible as a matter ofcourse.” It proposed that a number of “no brainer” changes beincorporated into individual pipeline tariffs to achieve suchflexibility. “Once these changes have been made, primary andsecondary service offerings will be better positioned to competeagainst each other, and to mitigate pipeline market power.” Only ifthese services become competitive should FERC then consider liftingthe 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 AmericanGas Association (AGA), a major LDC group, advocated expandingnegotiated authority for pipelines to include terms and conditions.INGAA called these “essential commercial tools,” and added itcontinued to support the AGA-INGAA proposal on this issue that wassubmitted to FERC in mid-1998. The pipelines insist they need theflexibility to meet the demands of the changing customer mix, whichincludes more power generators. The AGA said it would go along withgiving pipes negotiated authority, but only if a “high-qualityrecourse service” was available and the Commission’s expeditedcomplaint procedures were implemented. Such a recourse rate/servicewould have to “appropriately reflect cost reductions” and protectrecourse shippers against “subsidizing the market-responsiveservices offered under negotiated-rate policies.”

INGAA Supports Seasonal Rates

In an effort to eliminate the bias towards short-termcontracting, INGAA also asked the Commission to give pipes theoption to implement seasonal and/or term-differentiated rates. “Theprinciple underlying seasonal rates is to align the price ofcapacity with the usage of capacity, i.e. peak-priced contractswill have a higher price than off-peak contracts.Term-differentiated rates [will] more accurately reflect therelative level of risk that pipelines must face when sellingshort-term vs. long-term services.” Producers cautioned FERC totread carefully in this area until “fully articulated” proposalshave been put on the table. Specifically, Amoco Production,Burlington Resources Oil &amp Gas and Marathon Oil urged againstadopting “coercive” term-differentiated rates to force shippersinto long-term contracts.

Instead, the three producers asked FERC to mandate theirproposal for a three-part incentive rate structure, which wouldreward efficient pipelines with annual adjustments to their ratesof return on equity and permit sharing between pipes and customersof over- and under-recovery of annual revenues received forjurisdictional services. “…[T]his incentive rate model achieves abalanced sharing of risks and rewards…between the pipelines andtheir customers.”

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

“Providing preferential services through negotiated terms andconditions is fundamentally a zero sum game that can only adverselyaffect captive customers,” forcing them to subsidize the servicesof negotiated customers, the municipals said. Likewise, producerscontend such negotiated authority “will inevitably result inpreferential contracts, especially…between pipelines and theiraffiliates, whether they be in the business of producing,processing, gathering, marketing, distribution of gas or thegeneration of electricity.”

Additionally, the municipals insist expanding the negotiatedauthority of pipelines would “unfairly” devalue released capacity.It “slants the playing field” in favor of a pipeline by enabling itto “sell premium capacity at the same price that [a] captivecustomer can sell its inferior tariff capacity.” In short, it woulddeny municipals the one “fair opportunity” to market unneededcapacity for which they have paid “unduly high rates” due to FERC’sdiscount adjustment policy, they said in their comments.

Proponents contend pipelines need full negotiated authority tomeet the demands of gas-fired power generators and to further growthe market. But critics, such as the APGA, insist the “pell-mellscramble to build gas-fired electric generation” is occurringwithout this. It says pipelines can satisfy the special needs ofgenerators with flexible tariffs. “A new regime of special andblatantly discriminatory deals is not needed.”

On a related issue, Dynegy urged the Commission to reassessOrder 497, its pipeline affiliate rule, in light of the increasingconvergence between pipelines and electric utilities. First, FERCmust require pipeline affiliates to use real corporate dollars – asopposed to “funny money” or what amounts to intra-corporatetransfers – when bidding for recourse services or when paying fornegotiated services, it said. Secondly, FERC should amend Order 497such that “proscriptions against undue discrimination, informationsharing” would also apply to any Btu-related affiliate, whichincludes (but isn’t limited to) power generation affiliates.

INGAA and AGA supported removing the price caps, but only on thecapacity-release component of the short-term market. “This would bea positive step toward creating a truly competitive secondarymarket,” the AGA said. Caps on pipeline sales of short-term firmand interruptible capacity should remain, however, INGAA believes.Both opposed subjecting the uncapped capacity to competitiveauctioning, as FERC proposed. “The mandatory auction requirement isespecially inappropriate given that pipelines are not seeking toremove the price cap on pipeline sales of short-term firm andinterruptible capacity,” INGAA noted.

But the APGA called the price-cap removal the “most disturbingaspect” of all FERC’s initiatives. Trying to justify market ratesin the short-term market is akin to attempting to “stuff a squarepeg in a round hole. It will not fit.” Instead, it said cost-basedregulation of both the short-term and long-markets should continue.Producers also opposed abandoning rate caps – unless a showing ofcompetition in the market can be made. If FERC should actotherwise, however, they believe uncapped short-term capacityshould be subject to competitive auctioning. And, removal of ratecaps should be limited to transactions with a term of one calendarmonth or less.

The producers’ position on mandatory auctions – that they wouldbe “essential” if prices on short-term capacity were uncapped – wasthe closest thing to support that the Commission received for itscontroversial proposal. Dynegy, for one, said the goal of theCommission’s proposal was “laudable,” but added that “the game plan[was] not one that can be successfully executed.” Instead, itbelieves the Commission “should require pipelines to auction offall 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, “theCommission appears to view the gas market as headed full speed to adaily and perhaps hourly market. While there clearly is much moreday trading than there was a decade or even just a couple of yearsago, this is not the power market,” Dynegy reminded FERC. “There isno generator-like precision in wellhead production, and storage,line-pack and tolerable pressure swings can take up the slack whenconsumption inevitably does not match forecasts. Term transactions- those of 30 days or more – still account for the vast majority ofpurchases and sales, and will into the future…In the end, thereare too many variables to tell exactly where the market is going,or should go. The market is evolving naturally: there is no need topush it via regulation in any particular direction.”

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

It noted that it espoused auctioning of long-term capacitybecause it lacked many of the problems that were associated withauctioning on a short-term basis. “Specifically, problemsassociated with moving gas across the grid disappear because thereare not tight time restrictions on when upstream or downstreamcapacity must be purchased…Pricing volatility is greatly reducedbecause long-term pricing can be agreed upon upfront…Concernsregarding 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 directionbecause it would add costs and constraints to the market.”Moreover, it argued an auction mechanism would be unnecessary asprotection against potential market-power abuse, as FERC envisionedit, “because the secondary market in capacity is robustlycompetitive.” INGAA opposed it on legal grounds, saying a mandatoryauction without a reserve price violated the Natural Gas Act andthe U.S. Constitution “because it will deny pipelines anopportunity 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 ofstraight-fixed variable (SFV) rate design. INGAA urged theCommission to maintain SFV, saying that it promoted “efficientcompetition and [provided] accurate price signals.” However, itadded, “where circumstances warrant, pipelines should be permittedto deviate from SFV rate design in their individual ratesettlements.”

Municipals, on the other hand, believe a move away from SFV ratedesign to one that would put a greater portion of fixed costs in apipeline’s commodity rate would be the closest thing to a cure-allfor the industry. It would provide a solution to such industryconcerns as turned-back capacity, the bias against long-termcontracts, stunted throughput growth, and stranded costs associatedwith retail unbundling, they noted.

The APGA said it “wholeheartedly” endorsed a proposal submittedin February by a coalition of LDCs, which called for FERC tomandate a shift away from SFV for interstate pipelines and to adopta rebuttable presumption whereby 35% of pipeline fixed costs wouldbe recovered through volumetric/commodity rates. Producersindicated they would tolerate only a “limited movement away” fromSFV, with a maximum of 10%-15% of the fixed costs to be included inthe commodity rate.

Susan Parker

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