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Overhaul of Order 497 a Top Priority

Overhaul of Order 497 a Top Priority

FERC's marketing affiliate rule, which hinges on the hope that pipeline owners will police themselves, has been about as effective as a wolf guarding a henhouse, says a Washington D.C. lawyer who represents producers and independent marketers. Because of escalating abuses in the market, he believes overhauling Order 497 should be the first priority of the Commission in its post-Order 637 dialogue with the natural gas industry.

There "are some issues that simply will not wait. Chief among these issues are the recurring (in fact, growing) regulatory problems associated with pipeline-affiliate marketers," said Mark R. Haskell, co-managing partner of Brunenkant & Haskell LLP, last Thursday at the annual meeting of the Energy Bar Association. Order 497 was set up to stave off abuses between pipelines and their unregulated marketing affiliates, but it has failed miserably in that task and the "natural gas market is the worse for it," he noted.

"The failed regulatory model of Order 497 should be discarded in favor of a new regime of regulation that emulates structural separation to the maximum extent possible," he noted. Under such a regime, "new contracts between a pipeline and an affiliated marketer should be subject to strict scrutiny. Home pipe affiliates shouldn't be permitted to purchase capacity that has not been posted as being publicly available."

Also, he said, pipes shouldn't be allowed to use their marketing affiliates to bid up the price for capacity on their system under right of first refusal. And on the issue of "funny money," intra-corporate transfers of funds, a pipeline should be required to pay non-affiliated shippers the cost it incurs by "foregoing a business opportunity" with non-affiliates in favor of accepting a capacity bid from its marketing affiliate. This would eliminate the "built-in advantage" that affiliates have over non-affiliates when bidding for capacity on their home pipeline

But even these protections may not prove to be enough in the end. "If so, complete structural separation --- an outright ban on a pipeline affiliate marketer's ability to do business on its home pipeline --- must be considered" by FERC, Haskell said. Such a ban would be a last resort since it "might upset settled investment decisions and engender widespread opposition."

Marketing affiliates were the interstate pipelines' response to being stripped of their merchant function under Order 636, he noted. "As the merchant function passed into the annals of history, coincidentally and amazingly market affiliates were produced." And with their arrival, pipelines were able to hold onto their sales ability, Haskell said, adding that losing it was a just a "myth."

"Some of those affiliates have developed [into] businesses that are national in scope, with few if any ties to the home pipelines.....Others are still living at home with Mom. They don't want to move out." It's this latter group where the abuse or potential for abuse flourishes, he told the group of energy lawyers.

Just a "cursory review" of interstate pipeline "Index of Customers" at FERC underscores the close relationship between some affiliates and their parent pipelines, Haskell said. "Enron North America is one of the largest single shippers on its affiliate Northern Natural Gas Co. The listing of Reliant's affiliated shippers in its most recent filing runs for pages. Not only does Koch Energy Trading control substantial firm transportation capacity, but it also has contracted for more than 100 Bcf of PALS [parking and loan] service on its affiliated pipeline....."

Order 497 "was intended to curtail the built-in incentives for affiliate abuse. [But] the basis of that policy is and was flawed. At the heart of Order 497 is a philosophy of self-policing" by interstate pipelines that have "undeniable economic incentives to bend, break or 'interpret' rules in a manner sufficient to mask anti-competitive conduct," he noted

Weakness of Order 497

While some in the industry were encouraged by the tough action that FERC took against Kinder Morgan Inc. (KMI) in late March for affiliate abuses, Haskell wasn't one of them. If anything, he thinks the stipulation and consent agreement, ordering KMI to pay a civil fine of $5.1 million and make customer refunds underscores the weaknesses of Order 497. "The damages suffered by non-affiliated marketers cannot be measured simply in terms of rate refunds. Market opportunities were lost as a result of [the] proscribed conduct," he said.

Further adding to non-affiliate shippers' woes is the fact that interstate pipelines no longer have any "incentive" to file rate cases. "Pipelines can collect rates based on a 10-year filing, an eight-year filing. A pipeline can be passed around from holding company to holding company through mergers, changing its business risks, changing its.....overhead costs," but the same rates "are going to remain in place," Haskell noted.

"Malcontents" are told to file complaints at FERC, but only scant information is available at the Commission to help shippers' substantiate their charges. "The information currently available in pipeline Form 2 [reports] is virtually useless in this process," he said. "Potential complainants have.....disjointed, irrelevant data on a host of pipelines and little or no clear path of proving what should otherwise be obvious --- pipeline rates should be subject to periodic review under Section 5" of the Natural Gas Act.

In fact, "when pipelines are merged their rates should be subject to review automatically, without delay." At the rate the pipelines are going "if we have two more pipeline mergers, we could have the first [nationwide] RTO," he quipped.

Nor is Haskell a big fan of FERC's decision to remove the price caps on the capacity-release transactions on an experimental basis. He said it reminded him of when his nine-year-old son tried to convince his younger brother "to close his eyes and run real fast while standing in front of the garage door." How can FERC call this an experiment? he asked. "It's dangerous."

For M. Lisanne Crowley of the D.C. law firm of Crowell & Moring LLP, which represents LDCs, "[too] many issues were left open or subject to the pipeline's discretion" in Order 637. Haskell agreed noting the order "leaves for another day the most controversial issues" facing the gas industry. While this approach of "regulatory gradualism" may have some appeal in other industries, he said it doesn't work in a "dynamic" gas market.

Alice M. Fernandez, FERC's director of the Division of Tariffs and Rates-East, said she expects the Commission to begin its dialogue with the gas industry after it comes out with its rehearing order on Order 637, which should be "relatively soon." The gas industry "should have a busy summer" at FERC, she promised.

Susan Parker

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