Unlike pipes and shippers who appear to favor continuing negotiated rates, the California Public Utilities Commission (CPUC) called on FERC this week to halt the negotiated-rate program for pipelines, claiming it has turned jurisdictional pipes into profit-takers and has resulted in abuses that were unforeseen by the Commission when it instituted the practice six years ago.

“The pipelines and certain shippers have independently transformed the negotiated-rate policy into a license to engage in market-based pricing of capacity, selling capacity at whatever the market will bear,” the California regulators told FERC Wednesday [PL02-6]. FERC, when it authorized the use of negotiated rates in 1996, assumed that pipes would be deterred from abusing their market power in negotiating rates because they would be required to treat recourse rate bids as equal to negotiated bids when allocating capacity. But FERC’s theory hasn’t worked out in reality, the CPUC said.

“In practice the recourse rate has proven ineffective in precluding pipelines with market power from selling capacity at negotiated, market-based rates even though they do not have FERC authority to use market-based rates,” the CPUC said. “The ability of pipelines and shippers to make the recourse rate irrelevant amply warrants on its own a rescission of the negotiated-rate authorities.”

Only if FERC can “substantiate a critical need for the program” should negotiated rates be continued, the state agency noted. Even then, the negotiated-rate authority of pipelines “should be strictly circumscribed by specific regulations promulgated to assure compliance with cost-of-service regulation” under the Natural Gas Act.

Specifically, the CPUC proposed that FERC:

In addition to these safeguards, the CPUC said pipelines should be required to seek FERC approval of their negotiated-rate contracts at least 60 days prior to the contracts going into effect.

In a notice of inquiry (NOI) in July, the Commission asked the energy industry to comment on the future direction of the agency’s negotiated-rate policy and practices. It opened the NOI when it took disciplinary action against Enron Corp. subsidiary Transwestern Pipeline for charging shippers excessive negotiated rates during the California energy crisis in 2000-2001. FERC stripped Transwestern of its authority to negotiate rates based on basis differentials for one year and ordered the pipeline to pay refunds to customers who were charged the high rates (See Daily GPI, July 18).

Both Transwestern and PG&E Gas Transmission, Northwest Corp. (GTN) “used their negotiated-rate authority to extract their share of the aberrant profits of a dysfunctional market” during the 2000-2001 period, the California regulators said. “Transwestern reaped millions of dollars more than it would have under the maximum recourse rate.” while “even more egregious profits” were made by GTN.

In 1996, FERC issued its policy statement on negotiated rates to provide pipelines, which at the time were saddled with large amounts of turned-back capacity on their systems, with an alternative rate option to attract customers. Rather than signing up for capacity at a fixed rate under the recourse rate option, the negotiated-rate alternative offered customers the opportunity to customize rates to meet their market needs. Sometimes their fluctuating negotiated rates turned out to be higher than a pipeline’s maximum recourse rates, while at other times they were lower.

The reasons behind the regulatory change were not “sufficiently developed” by FERC in its policy statement, and as a result the agency was blinded to the possibility that pipelines would take advantage of this practice, the CPUC noted. FERC apparently did not foresee that pipes “would be opportunistic on an ongoing basis” and negotiate rates above tariffed maximum rates, it said.

“The FERC also may not have foreseen that negotiated-rate authority would be used by pipelines to enter into hedging-type contracts in which a shipper gambled on future commodity prices or readily agreed to a rate higher than the recourse rate to be sure of acquiring capacity, the availability of which was controlled by a pipeline with market power.”

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