After 18 months in the making, the much-anticipated mega-rule,initiating a host of post-Order 636 gas transportation and ratereforms made its public debut last week. The rule got good reviewsfrom pipeline customers but immediate criticism from a majorinterstate pipeline.

Two main features of the rule, lifting price caps on releasedcapacity and allowing different rates based on the season or thelength of the contract, are aimed at making more capacity availableto the market and encouraging longer term contracts.

LDCs, marketers and industrial gas customers gave FERC’sshowpiece high marks, but “I don’t think this rule went far enoughto meet the needs of future markets,” which will be “180 degreesdifferent from the markets served in the past,” said CubaWadlington, president and CEO of Williams Gas Pipeline. He believesa number of issues will have to be re-addressed. Even FERC ChairmanJames Hoecker and Commissioner Curt Hebert Jr. conceded they wouldhave preferred the rule to have gone further in some areas.

The centerpiece of the 268-page final rule was the Commission’sdecision to lift price caps on short-term capacity releasetransactions (less than one year) on an experimental basis for twoand a half years — until Sept. 30, 2002, at which point it willdecide either to extend or eliminate it. The American GasAssociation (AGA), which represents major holders of capacity inthe secondary market (LDCs), called this a “significant victory”for gas utilities.

Even industrial gas customers, who were opposed to theCommission’s original proposal that called for removal of pricecaps in the entire short-term pipeline market, said they could livewith the initiative. “At least it’s an experimental program and atleast it’s only limited to capacity release,” remarked Ed Grenier,a Washington D.C. attorney for the Process Gas Consumers Group(PGC). “I think [pipeline] customers got a lot” in the final rule.”Certainly the holders of [release] capacity…..got a bigsomething.”

For pipelines, the final rule offered alternative pricingoptions in the form of seasonal rates for short-term capacity andterm-differentiated rates for both short-term and long-termcapacity. But, as a protection for pipeline customers, the”pipelines will have to jump through some hoops to get theterm-differentiated rates,” PGC’s Grenier said. They will have toapply for term-differentiated rates in a general Section 4 filing.This is not a popular option with pipelines, which have gotten outof the habit of filing rate cases since Order 636.

If pipelines should collect more than their annual cost ofservice under seasonal rates, the final rule requires them to give50% of the revenue excess back to their customers. “That takes awaythe whole purpose of seasonal rates,” Wadlington said.

Noticeably absent were two of the most controversial proposalsthat FERC had considered — allowing interstate gas pipelines andtheir customers to individually tailor the terms and conditions ofservice, and mandating that pipelines conduct daily capacityauctions in return for the removal of the price caps in the entireshort-term pipeline market, which includes released capacity,pipeline short-term firm and pipeline interruptible.

The Commission’s decision to disallow the proposal on negotiatedterms and conditions was a “step back in terms of letting themarket be a greater factor in determining how [pipeline] servicesshould be priced. It took the market factor out of the equation,”noted Williams’ Wadlington. The exclusion of a mandatory auctionwas a relief to nearly the entire gas industry, with the exceptionof a few producers.

The final rule “may be the most important generic decision theCommission has made in the gas industry since Order 636,” whichwent into effect eight years ago, Hoecker said. But, he cautioned,”this is not 636 or [Order] 888. It does not fundamentally re-orderthe commercial relationships in the market in the way those ordersdid…..This order represents what industry and publicpolicy-makers must do ‘after’ a competitive market has beenestablished.” The rule essentially is the next step in atransitional gas market, where the commodity is fully deregulatedand transportation is only partly deregulated, a FERC staff membersaid.

The rulemaking incorporates a number of measures that were partof the notice of proposed rulemaking (NOPR) on short-term gasmarkets and the notice of inquiry (NOI) addressing the regulationof long-term transportation services, which were issued in July1998 (RM98-10, RM98-12).

Hoecker: It’s ‘Not a Perfect Rule’

Remarkably, none of the commissioners dissented Wednesday, butthat didn’t mean they supported everything in the rule. “This isnot a perfect rule, I don’t think. I would have strongly preferredlifting the price cap on the release market for longer or perhapspermanently,” Hoecker said. Still, “I think the less-inhibitedsecondary market will prove itself as a very effective way todiscipline and reduce the price of capacity overall, but especiallyin the short-term market.”

Commissioner Hebert said he found the decision to lift the capsfor only a two-year period “unacceptable.”

FERC said it planned to “actively” monitor the effects of theremoval of the price ceiling to determine whether any changes maybe needed before September 2002, when the waiver expires. “As thewaiver period progresses, I will be particularly watchful formarket-power issues, such as the withholding of capacity and pricespikes,” said Commissioner Linda K. Breathitt.

She believes the Commission’s action will lead to multiplebenefits. “Uncapped capacity release rates may encourage shippersto make more firm capacity available……[and] releasing thepricing cap could act to make peak-period transactions moretransparent.”

As a result of the new rule, the AGA said utilities will be”compensated more fairly for the valuable capacity they” re-sellinto the secondary market. The LDC group also applauded the”creative compromise” that FERC reached with respect to seasonalratemaking, which will permit pipelines to collect a greater amountof their reservation charges during peak demand periods. The AGAwas concerned the seasonal-rate proposal would shift to traditionalgas consumers some of the pipeline costs associated with meetingelectric generators’ peak summertime load.

But FERC “appears to have permitted pipelines to file for peakand off-peak rates to accommodate seasonal demand of certainsegments of the market, without harming utilities and theircustomers,” said Roger Cooper, AGA’s executive vice president forpolicy and planning. The 50% revenue crediting provision willprovide “benefits to gas utility customers who pay for pipelinecapacity throughout the year.”

In addition to seasonal pricing, term-differentiated pricingwill permit pipes to assess lower rates for longer term contractsand higher rates for shorter term contracts. The Commissionbelieves this will induce pipeline customers to contract for longerterms.

Negotiated Terms and Conditions Nixed

With respect to negotiated terms and conditions of service, FERCconcluded “this is an issue that warrants further deliberations”within the Commission and the industry.

Dynegy Inc., a major gas and power marketer, “likes the ideathat they denied negotiated terms and conditions,” said PeterEsposito, vice president and regulatory counsel. “But the realquestion is how much customization they’re going to allow” withinthe bounds of generally applicable pipeline tariffs. “Our fear isthat if the market becomes so segmented it’s going to be difficultto achieve efficiencies and economies of scale.” The Commission’schallenge now is to “balance the need for flexibility with the needfor a more commoditized [transportation] service that can becombined across pipelines.”

Although the much-dreaded initiative calling for dailyauctioning of pipeline capacity also failed to make the final cut,Commissioner William Massey noted the rule does provide for a”voluntary auction process that I hope will lead to creativeproposals.”

Many of the less-controversial issues, which Breathitt hadtouted all along, were included in the final action. FERC adopted”new regulations to require equality in scheduling…..betweenreleased capacity and pipeline capacity. This is an important stepin placing capacity-release transactions on a more equal footingwith pipeline services,” she said. Also, the rule “standardizes andcodifies the Commission’s policies concerning segmentation rights.This change should increase shippers’ alternative capacity sourcesand, therefore, enhance competition.”

Under the segmenting category, Dynegy’s Esposito said the ruledidn’t go far enough because it refused to allow, for example, acustomer to drop gas off in New York on a firm contract to Bostonwithout paying more or suffering lesser priority, even though thegas would be scheduled to pass by New York on its way to Boston.

Additionally, the rule encourages pipelines to rely less onpenalties and operational flow orders. It “move[s] away from thepipeline ‘command-and-control’ penalty scheme towards a system thatis intended to provide the correct incentives for pipelines andshippers to avoid the need to impose penalties,” Breathitt said.The rule also imposes real-time reporting requirements on allpipeline capacity transactions, which “will result in the kind oftransactional transparency that is necessary to allow theCommission and market participants…determine whether markets arefunctioning free of interference, affiliate abuse or theanti-competitive withholding of capacity, Massey said.”

Susan Parker

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