El Paso Merchant Energy racked up a total of $691 million in hedging losses in the first 13 months of its contract for 1.2 Bcf/d of capacity on affiliate El Paso Natural Gas, making it imperative for the trading arm to flow as much gas as it could to California to help make up those losses, the company revealed in a Federal Energy Regulatory Commission hearing this week.

The loss figures due to overhedging, including $262 million from the start of the contract March 1, 2000 through the end of the year and $429 million in the first quarter of this year, were part of the prepared testimony of Ralph Eads, president of El Paso Merchant Energy Group, which had originally been filed in the case under protective cover before Chief Administrative Law Judge Curtis Wagner. The protected material designation was removed Tuesday and the losses were made part of the public record. El Paso Merchant, defending against charges that it had market power and used it to hike California border prices, argued that taking the large hedge position was not the typical strategy of a market participant which believed it could control the market and run up prices.

Eads said it was a strategy based on the fact that the capacity historically had been underutilized. Also he noted that the Block I, II and III capacity under the 18- month contract (which expires at the end of this month) included service limitations and restrictions that effectively restricted full capacity “Merchant recognized that throughput was low at the PG&E-Topock and SoCal-Ehrenberg delivery points during many periods in the past. What Merchant needed to hedge against was the possibility that basis differentials to the California border would fall, which would mean that demand was weak and the capacity would continue to be underutilized.”

Historically, Eads said, load factors had been about 50% and the basis spread between the San Juan Basin and California had ranged from 20 cents to 50 cents/MMBtu. While it hoped to increase throughput, “Merchant expected neither the magnitude nor the duration of the high gas prices and increased basis differentials experienced at the California border over the past 11 months. Thus, El Paso’s losses on its hedging transactions have been much higher than it expected.”

Contrary to charges by the California Public Utilities Commission (CPUC) that it had restricted the use of its capacity, Eads said the way to recoup some of those losses was to flow gas. Because of the restrictions on receipt and delivery points and other factors it was not possible to use all the capacity all of the time. El Paso Merchant never considered purposely withholding capacity to affect prices “because it was obvious to Merchant…that Merchant could not affect prices at border by withholding capacity because of the sheer size of the market and large number of participants.” Especially with the basis differentials above maximum pipeline tariff rates, others would readily pick up any unused capacity on an interruptible basis, Eads said.

Another controversial document, filed by the CPUC and placed under protective seal — available only to parties in the case — got an airing of sorts in the hearing Tuesday when Judge Wagner commented that it “certainly has statements in it that could lead one to believe there was an abuse” of market power. The New York Times has reported that in a Feb. 14, 2000 memo it had obtained, El Paso Merchant said that its contracted capacity would give it more control of the market. Attorneys would not comment on the contents of the document. However, El Paso Merchant attorney Bill Scherman said the judge’s comment came before El Paso had a chance to testify on the subject, indicating that testimony would rebut the market power conclusion.

Scherman and an attorney for the pipeline spent most of the first two days of the hearing tearing apart the prepared testimony of the CPUC, which brought the complaint against the conglomerate. Under cross examination Sandra Rovetti, the author of the CPUC’s complaint, admitted that in attributing the high basis differentials and corresponding border prices to El Paso, she did not consider other factors such as capacity released or available on other pipelines, receipt or delivery point restraints on Merchant’s capacity, the lack of takeaway capacity at the border and the fact that even primary shippers experienced cutbacks in their border deliveries or receipts out of the San Juan Basin. Nor in her evaluation of prices did she consider what Scherman called “highly relevant” items, such as the low storage levels in the West and the slow build up of storage, increases in demand for power generation, or high oil prices.

The CPUC testimony focused on the fact that the magnitude of the basis differential from the producing areas to the border steadily increased after El Paso Merchant took over the capacity. The analysis covered the period from March 1, 2000 when El Paso Merchant took over the capacity until Aug. 18, the day before an explosion on the El Paso pipeline. Rovetti’s testimony discussed how El Paso Merchant could have made a profit by offering short term released capacity at unattractive rates and conditions in order to discourage other marketers from bidding on it. The CPUC had objected early on to allotting the capacity to the pipeline’s affiliate, saying that would discourage El Paso Natural Gas from selling interruptible capacity in competition with its merchant trading arm.

El Paso’s attorneys charged the CPUC’s testimony was influenced by a study prepared by the Brattle Group of Cambridge, MA, and paid for by Southern California Edison, which also has lined up against El Paso, attempting to shift the blame for the power price run-up in California. Last week El Paso charged the same group had coached state legislators, turning a California Assembly subcommittee hearing which found El Paso at fault into a “charade that was orchestrated from the beginning” (see Daily GPI, May 15)

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