Financial analysts and El Paso Corp. executives greeted the long-awaited decision by FERC Chief ALJ Curtis Wagner Jr. last week in the high-profile big rigging and price manipulation case as extremely positive for El Paso, even though the judge didn’t completely exonerate the company.

In a split decision, Wagner ruled last Tuesday that El Paso Natural Gas had engaged in “blatant collusion” by maneuvering the bidding process for a large block of transportation capacity on its system to favor its merchant-power affiliate. However, he recommended dismissal of the charge that El Paso Merchant Energy Co. illegally exercised market power to drive up prices for natural gas delivered to southern California beginning in mid-2000.

El Paso Corp. Chairman William Wise said he was “absolutely convinced” FERC would overturn the ALJ ruling that found El Paso Natural Gas skirted the Commission’s affiliate standards by giving El Paso Merchant an edge over other shippers in the bidding process. But even if the agency doesn’t do this, he said it was unlikely that the company would be slapped with a major penalty.

“There has never [been a] penalty assessed of more than $8 or $10 million in an affiliate violation case,” Wise said during a teleconference with reporters and analysts last Wednesday. In a worst-case scenario, the Commission could order El Paso Merchant Energy — the chief beneficiary of the affiliate violations — to disgorge all of the profits that it made during the period that it held the capacity, which Wagner estimated in his initial decision were $185 million, Wise said. But that action by FERC “would be extraordinary and certainly without precedent” as a remedy.

California regulators and others had argued that El Paso Merchant ended up the big winner in the February 2000 open season, snaring three contracts for 1.22 Bcf/d of firm capacity on the El Paso pipeline, because it received inside information about a discount interruptible transportation rate on El Paso affiliate Mojave Pipeline, while non-affiliate bidders weren’t privy to the same information. That information, critics said, gave El Paso Merchant an advantage over non-affiliate shippers when bidding for the capacity.

But even if FERC should order the profits to be disgorged, Wise said El Paso Merchant still would have a “zero sum game” in California, once offsetting receivables owed by state utilities are collected. He said California utilities currently owe El Paso “significant dollars,” which he estimated were in the range of $200 million.

In the end, Wise said he believes the likely scenario will be that “we will convince the Commission that our position [on the affiliate issues] is correct, or that…a much smaller penalty, if any,” should be assessed.

He noted he has not dismissed the prospect of reaching a settlement with the California Public Utilities Commission and other parties on the affiliate issue, which filed the complaint charges against El Paso. “[I am] not averse to settling this matter,” Wise said, adding that he would have to first see “how much reality [has been] put into the formula” in the wake of Wagner’s decision.

Wise said he was “very pleased” with Wagner’s ruling that El Paso Merchant did not appear to flex its market power to drive up prices for gas delivered to southern California beginning in mid-2000. Although the judge found that El Paso had market power, he said there was no evidence to suggest that the company exercised it to manipulate prices. Wagner recommended that the full Commission dismiss these charges. The CPUC, which has alleged that El Paso’s actions resulted in $3.7 billion in overcharges to California energy customers, said last week it plans to appeal this decision at FERC within the next 30 days.

Wagner’s decision on the market-power issues was “well reasoned and supportable,” said Wise, adding that he “completely agreed with our position.”

In an analysis of the ALJ decision, Credit Suisse Equity Research concluded that the rulings on both the affiliate and market-power issues were “enormously positive for [El Paso] in that they greatly minimize the risk of civil lawsuits or other actions that could have resulted in liabilities of billions of dollars.”

At this stage, “we consider the ‘worst case’ for [El Paso] to be a ‘disgorgement of profits’ plus other fines in the range of $180-$200 million,” according to analyst Curt Launer.

UBS Warburg reached similar conclusions. “Though not a clean sweep, we believe the net outcome from his [Wagner’s] decisions are a substantial positive for El Paso, and have significantly reduced the company’s limited exposure to the highly politicized California mess,” said analyst Ronald Barone in a “Research Note.”

Barone said he expects a “minimal fine or settlement” of the affiliate-abuse charges in the worst-case scenario. “This is particularly true, now that the FERC is issuing new affiliate rules which should help minimize situations where abuse may appear to occur.”

As for Wagner’s market-power ruling, Barone said he’s not discounting the possibility that the CPUC and California utilities will appeal the case to the U.S. Court of Appeals for the D.C. Circuit, after exhausting the rehearing process at FERC. “If this were to occur, we would not rule out El Paso settling out of court for a reasonable amount in order to put this ordeal behind it. If the plaintiff’s requests were moderate to substantial…we would expect a legal battle with El Paso emerging as the clear victor,” he said.

In his initial decision, Wagner said what convinced him that El Paso pipeline’s bidding process was tilted towards El Paso Merchant was a transcript of a telephone call between Robin Cox, vice president of El Paso Merchant, and Harvey Rodman of El Paso affiliate, Mojave Pipeline, which markets transportation for both El Paso pipeline and Mojave. Based on that, “it [was] clear to the Chief Judge that a deal was reached during the open season for a term discount that other [El Paso] potential shippers were not aware of,” he said.

“These telephone transcripts demonstrate blatant collusion on the part of El Paso Merchant and Mojave/El Paso pipeline to keep secret a discount for service on the downstream Mojave system until the open season ended, giving El Paso Merchant an advantage in making its bid for the total 1,220 MMBtu/d offered” on the El Paso pipeline.

Despite his “strong urging” during the hearing this summer, Wagner noted that El Paso officials refused to produce Cox and Rodman as witnesses. Even then, the FERC judge called the telephone transcripts “devastating.”

Wagner specifically noted that El Paso pipeline violated two of the Commission’s standards of conduct — one that requires pipeline operating personnel and marketing-affiliate personnel to function independently of each other, and a second that prohibits an interstate pipeline from sharing information solely with its marketing affiliates and not with non-affiliates shippers on its system.

In his ruling, Wagner noted that El Paso’s Wise approved El Paso Merchant’s bid for the transportation capacity on El Paso pipeline. “Getting this important evidence from [El Paso Merchant’s] Ralph Eads was a rather difficult job,” he said.

He further pointed to an April 14, 2000 memo from El Paso Merchant President Greg Jenkins to Wise, with a copy sent to John Somerhalder, executive vice president of El Paso’s pipeline group. “The sharing of this document which discusses nearly every aspect of El Paso Merchant’s business, including what was necessary to make a profit and what must happen if it is to make money, indicates clearly that there was no firewall between El Paso Pipeline and El Paso Merchant,” Wagner said.

Interestingly, he recognized the need for large companies, such as El Paso Corp., to “exercise more control over [their] affiliates” in today’s business environment. “In the opinion of the Chief Judge, the officers of parent companies would be derelict in their duties if they did not exercise some degree of supervision and approval over important decisions, particularly in matters with a magnitude as large as that involved in this proceeding.” But, he added, “it must be kept in mind that here there was a dialog between the pipeline affiliates and the marketing affiliate that gave an unfair advantage to the bidding in the open season.”

As for the second allegation of market power, Wagner said he found that while El Paso pipeline and El Paso Merchant had the ability to exercise market power — the capacity to significantly manipulate prices to their advantage — “the record in this case is not at all clear that they in fact exercised market power.” Given this, he recommended to the full Commission that these charges be dismissed.

Even though the “three contracts gave El Paso Merchant additional capacity of 1,220 MMBtu/d and…El Paso Pipeline is one of the largest pipeline companies in the United States, ranking eighth in operating revenue, seventh in peak rate send-out, fourth in miles of transmission pipe, and fourth in number of compression stations in the nation,” Wagner said he “recognizes that size alone is not sufficient to find market power.”

If anything, “the evidence in this case shows that El Paso Pipeline did in fact comply with Order Nos. 637 and 637-A,” which Wagner said signals that the “exercise of market power by the withholding of capacity by an affiliate or any other shipper on a pipeline is prevented.”

The Commission has about 60 days to either accept, reject or modify Wagner’s rulings in the case.

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