Transwestern Pipeline earlier this year illegally charged shippers market-based rates for firm transportation capacity to the California border “under the guise of negotiated rates,” according to prepared testimony of an energy industry analyst with the Federal Energy Regulatory Commission.

The Commission “has never granted Transwestern the authority to charge market-based rates for interstate natural gas transportation. Nevertheless, in the dysfunctional Southern California natural gas market, and in particular during the recent January 2001 to March 2001 period…Transwestern clearly exercised its market power to arrange negotiated-rate deals before properly posting [its] operationally available capacity on its web site,” said Barry E. Sullivan, a supervisory analyst with the Office of Markets, Tariffs and Rates’ Division of Litigation.

Sullivan’s testimony will be included in the hearing that begins Wednesday [RP97-288]. It will explore whether Transwestern exercised market power in awarding negotiated-rate contracts that led to shippers being charged as much as $27/MMBtu in February, when the effective maximum rate allowed under its tariff for firm transportation service to the California border was only 38 cents/MMBtu. FERC called for the hearing in a late July order.

Transwestern discussed capacity availability on its system with two shippers — Sempra Energy and Richardson Products II Ltd. — prior to actually posting the capacity on its web site, Sullivan said. Such pre-posting discussions often raise doubts about the availability of capacity at the maximum recourse rate, he explained, and might make shippers more “willing to enter into negotiated-rate contracts above the recourse rate, in the hope of securing some of the capacity if and when [it] became available.”

This is tantamount to withholding of capacity on Transwestern, he noted. “The reason this behavior is problematic is that Transwestern is able to capture part of the price differential” between the California border and the Southwest producing basins “by threatening to withhold the capacity unless the shipper agrees to the negotiated rates.”

Although the capacity was posted by Transwestern for one business day and open to all of the pipeline’s shippers at maximum recourse rates, “no party other than the shippers (Sempra and Richardson) that actually acquired the capacity [at negotiated rates], bid on this short-term excess firm capacity,” Sullivan said.

He said he found this puzzling. “At that time, capacity into southern California was at a premium…Shippers could make extraordinary profits if they could move gas to southern California. Yet, no other shippers bid on this capacity, even at a discounted rate.”

Under their negotiated-rate deals, Sempra Energy and Richardson settled for “small guaranteed” profits, while Transwestern reaped huge profits from the transactions, said Sullivan. It “is difficult to accept the conclusion that one of these shippers [Sempra] willingly negotiated away a virtually risk-free profit of approximately $5 million, settling instead for a completely risk-free profit of approximately $200,000, while another [Richardson] willingly agreed to forego additional profits of almost $2 million.”

If Sempra Energy had opted to pay the maximum recourse rate under Transwestern’s tariff, Sullivan estimated that the company’s profits would have been more than $5.2 million, compared to the estimated $210,000 that it received under the negotiated-rate deal. Richardson’s profits from the capacity would have been almost double those of last February — $3.4 million rather than $1.8 million, he said.

Transwestern, on the other hand, received more than $5 million from Sempra Energy’s two contracts last February, he calculated, and about $1.8 million from the Richardson contract arrangement.

Transwestern witnesses said Sempra Energy and Richardson agreed to the negotiated-rate deals — and smaller profits — to avoid paying demand costs in the event their gas did not flow. But Sullivan called this argument “spurious” since the “contracts were for day-to-day service, with either party able to cancel with two hours notice.”

Moreover, he noted that Sempra Energy would have had to pay only $5,700/day under its February contract deal of 15,000 MMBtu/d if the gas had not flowed and Sempra failed to give Transwestern two hours notice. “Clearly, the downside risk was minimal when compared to the potential upside gain.”

The price differential between the southern California border and the Southwest producing basins would have had to slip below $1.18 for the negotiated rates to have been a better business deal for Sempra Energy than the recourse rate, Sullivan said. But for the last 10 days of January, which was part of the bid period, the price differentials ranged from a low of $5.01 to a high of $9.25, with a ten-day average of $7.36.

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