The Federal Energy Regulatory Commission, in a 2-to-1 split vote, has agreed to prospectively prohibit interstate pipelines from entering into negotiated-rate transactions with shippers which reference “basis,” or the difference between the natural gas price indexes at two points, citing the potential for pipelines to manipulate spot gas prices.

In voting to amend the agency’s negotiated-rate policy, the Commission majority said it was concerned its 1996 policy statement gives pipelines an incentive to withhold capacity in an attempt widen the basis between index points and drive up transportation rates. Commissioner Nora M. Brownell dissented, calling the majority’s blanket prohibition against negotiated-rate transactions that use gas basis differentials “prescriptive and an unnecessary intrusion in the marketplace.” She argued that most basis differential priced transactions were below cost-based recourse rates.

FERC’s “negotiated-rate policy permits pipelines to charge rates above the maximum cost-of-service rate, thus presenting the possibility that a pipeline could increase revenues by withholding capacity,” the order said [PL02-6]. While the availability of a cost-based recourse rate is supposed to act as a check against pipeline market power, “this may not be true where the negotiated transportation rate is tied to the commodity price of gas,” it noted.

In addition to a pipeline having a vested interest in widening the basis differential to raise its transportation rate, “the shipper may have little incentive not to agree [to a higher rate] since it is either held harmless or may, in fact, share in the profits from the increased price differential,” according to the FERC order.

The Commission’s action stems from a notice of inquiry (NOI) that began in July 2002 into all negotiated-rate transportation deals that are tied to basis differentials. FERC initiated the inquiry at the same time it suspended for one year the authority of Enron subsidiary Transwestern Pipeline Co. to negotiate rates based on basis differentials and ordered refunds for excessive rates charged during the California energy crisis in 2000-2001.

At the time, Chairman Pat Wood said he feared Transwestern’s practice of tying transportation rates to spot gas prices at different points was “putting the pipelines back in the business we worked so hard to get them out of — that is, of having a vested interest in the commodity market.” This type of negotiated-rate transaction “[puts] them back in the saddle very directly, in a relatively covert way,” he noted.

In the latest order, FERC said, “pricing mechanisms that invest pipelines with an incentive to use market power to manipulate the commodity price of gas hinder the Commission’s attempt to maintain and improve the competitive natural gas market.” To allow pipes to enter into index-based negotiated rate deals, “reverses the regulatory trend which is based upon the competitive transportation structure acting to ensure competitive natural gas markets.”

The Commission further cautioned pipelines that it will expect more detailed filings on negotiated-rate transactions from pipelines in the future. “The Commission’s experience with negotiated-rate filings has shown that the filings on occasion lack the information necessary for the Commission’s staff and the pipelines’ shippers to analyze the agreement.”

The agency said it will expect a pipeline filing a negotiated-rate transaction that doesn’t deviate from its pro forma service agreement to file a tariff sheet identifying the terms of the agreement, as well as a statement that the agreement conforms in all aspects with its pro forma service agreement. Pipelines must “fully describe the essential elements of the transaction, including the name of the shipper, the negotiated rate, the type of service, the receipt and delivery points…and the volume of gas to be transported,” FERC said.

In addition, “where the price term of the negotiated-rate agreement is a formula, the formula should be fully set forth in the tariff sheet,” according to the order. Pipelines also “must certify that the agreement contains no deviation from the form of service agreement that goes beyond filling in the blank spaces or that affects the substantive rights of the parties in any way.”

To provide greater transparency, FERC also “will henceforward require that a pipeline filing a contract proposing material changes from its form of service agreement must clearly delineate differences between its negotiated contractual terms and that of its form of service agreement in redline and strikeout.” Specifically, the pipe should provide a “detailed narrative outlining the terms of its negotiated contract, the manner in which such terms differ from its form of service agreement, the effect of such terms on the rights of the parties, and why such deviation does not present a risk of undue discrimination.”

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