Major energy providers and users alike last week attacked FERC staff’s efforts to establish a new pricing formula that would lower the purchase costs power generators could legitimately claim for natural gas used to produce electricity during the California energy crisis nearly two years ago — a move that, if successful, would raise the level of potential refunds owed by generators to state energy consumers. They urged the Commission to jettison staff’s proposed pricing alternative, arguing staff fell far short of proving that the conventional method used for computing generators’ gas costs — published price indices — had been successfully manipulated to the point where gas prices were inflated.

But California regulators and other state officials said recent disclosures by energy companies that rogue employees submitted bogus gas prices to trade newsletters that publish price indices, as well as an unfavorable ruling against El Paso Natural Gas by a FERC judge last month, provided justification for FERC staff’s proposal to suspend the use of reported prices for California-delivered gas when computing the natural gas costs of California generators involved in the ongoing refund proceeding at FERC.

Staff’s proposed pricing alternative “is…supported by the recent revelations by Dynegy Inc. and American Electric Power [AEP] that certain of their employees furnished inaccurate information to publications that compile and report index prices,” said the California Public Utilities Commission (CPUC), the California Electricity Oversight Board, state Attorney General Bill Lockyer and others [EL00-95-045]. They also cited the ruling last month by FERC Chief Judge Curtis Wagner, who found that El Paso pipeline had withheld substantial volumes of capacity from the California market during the 2000-2001 energy crisis to drive up prices at the state’s border.

“Staff…establishes that these [published price] indices cannot be validated and are subject to manipulation and the exercise of market power,” noted California regulators and officials.

The Commodity Futures Trading Commission is investigating the disclosures by Dynegy and AEP, and has subpoenaed gas pricing information from Platts, which publishes Gas Daily and Inside FERC’s Gas Market Report and is owned by McGraw-Hill. Houston-based Dynegy disclosed late Friday it had fired six employees and will discipline seven others for supplying false prices for gas trades to energy industry newsletters, but it did not say which publications received the bogus data, when or whether this caused prices to be inflated at certain delivery points (See Related Story). Despite the revelations, however, energy buyers and sellers said last week they weren’t willing to forego the use of the published price indexes in light of FERC staff’s failure to demonstrate that the reported gas prices had been compromised.

In proposing its new pricing approach, FERC staff “purported to identify potential sources of problems with published [gas price] indices,” said the Los Angeles Department of Water and Power (LADWP). But it “failed to take the next step, which is to determine if misreporting and other manipulative practices actually artificially raised the published index prices and, most importantly, to determine if generators, in fact, paid such misreported prices when they purchased the gas they used to generate electricity during the refund period.”

The failure of FERC staff to “quantify the extent to which prices were successfully manipulated upward or downward shows that staff has not reported sufficient evidence to support replacement of existing [pricing] methodology,” the municipal electric provider told the Commission last week. The LADWP pointed out that the agency staff itself cited the lengths to which trade publications who gather/publish prices go — such as surveying a “diverse range” of companies and “cross checking” data to identify “anomalous data” — to shield against attempts by companies to manipulate prices for natural gas in California and other energy markets.

FERC staff recommended changing the formula for computing California spot gas prices as part of the agency’s initial report on the status of its ongoing investigation into manipulation of energy prices in western markets, which was released in August. Specifically, staff proposed that, for the purpose of determining the amount of customer refunds owed by electricity generators, gas prices in California or at the state border should be based on published spot prices at selected production basins (San Juan and Permian), plus the regulated cost of transportation, rather than on the high costs for gas delivered to the state that existed during 2000-2001 (see NGI, Aug. 19). Gas costs are a significant consideration when calculating the amount of refunds owed by California power generators, given that many generation plants in the state operate on natural gas.

Some have speculated that establishing a new reference price for gas delivered to California for the 2000-2001 period would add another $1 billion to the potential refund obligations of generators in the state, which already have been pegged at roughly $8 to $9 billion.

The staff’s proposal is at odds with the existing method for establishing the actual gas prices paid by power generators, which is based on the simple average daily spot price as reported by Natural Gas Intelligence’s Daily Gas Price Index, Inside FERC’s Gas Market Report and Gas Daily. The net effect of staff’s recommendation, if adopted by the full Commission, would be to reduce the gas costs that power generators could claim they incurred during the California energy crisis, which would result in a corresponding increase in the level of refunds owed by generators for that period.

The CPUC and other state officials contend that FERC staff’s pricing alternative — tying California spot gas prices to producing basin prices — would provide an adequate reflection of gas prices during the 2000-2001 period. “There is no evidence in the record…to suggest that power suppliers were unable to purchase gas at or below the prices yield by the proposed staff proxy calculation — in fact, power suppliers have steadfastly avoided providing any actual data…on their gas purchasing during the refund period.”

The CPUC and others, however, noted they support staff’s proposal to offer electricity sellers an optional cost-based mechanism to recover verifiable, legitimate costs (including gas costs). This would give power sellers “who truly had costs in excess of the rates allowed under the refund methodology…a reasonable opportunity to recover their costs…[It] lets the parties finalize refunds and move forward with the business of running electric utilities and natural gas pipelines.”

In proposing the revision, FERC staff claimed California gas prices as reported in published price indices were unreliable and unverifiable, and hinted strongly that they were easily subject to manipulation. Even if staff had proven the published gas prices being used to compute the mitigated market clearing price (MMCP) for electricity in California were manipulated, the LADWP argued that “the use of such prices is reasonable if generators actually paid the manipulated prices.” This, it noted, is the “most critical defect” in staff’s recommendation.

The staff proposal would “unfairly punish” California power generators who had to buy gas at whatever the price to supply electricity to the state, the LADWP said. “Generators were price takers who had to pay the going rate for gas in order to generate, even if such price was excessive due to scarcity, market manipulation, market failure or any other factor. Generators did not have the option of refusing to purchase gas and allowing the lights to go off in California.”

Assuming price manipulation affected spot gas prices, which the LADWP doubts, it said the Commission should take action against abusing gas marketers and pipelines, not power generators. “In short, the remedy for gas market manipulation, if it occurred, is not in a proceeding that addresses refund liability of electricity suppliers for sales of electricity in the [Cal-ISO and Power Exchange] electricity markets during the refund period,” said the municipal utility, which in addition to supplying power to its own customers, sold surplus energy to the state wholesale market during the 2000-2001 crisis.

In opposing staff’s proposal, the Natural Gas Supply Association (NGSA) urged the Commission to “recognize” that there were a number of reasons, other than price manipulation, for high gas prices during the California energy crisis, including unprecedented gas demand by power generators, inadequate intrastate pipeline infrastructure, and “poorly conceived regulations at the electric retail level” in the state, all of which “[were] exacerbated by a hot and dry summer.”

The NGSA, which represents gas producers who sell to California, asked FERC to first conduct an analysis of competition in the gas market at the California border to determine whether market-power abuse could have occurred during the 2000-2001 period. If evidence of market-power abuse is found, it believes the agency “should at minimum guarantee recognition of actual natural gas costs by those market participants” who were not involved in any price manipulation. Lastly, “whatever methodology for calculating gas costs for electric refunds that [is] decided by the FERC should be limited to this proceeding and not used for any other purpose.”

In the meantime, the producer group called on the Commission to “continue its proactive investigations and penalize market players who have exercised market power and/or violated the FERC’s regulations.”

The Electric Power Supply Association (EPSA) said staff’s recommendation “does not reflect a true or meaningful natural gas market price” for the 2000-2001 period because it fails to “recognize that, during times of shortages, prices must and do derive from the customer’s value, not the supplier’s costs, if adequate supplies are to be available.”

The high gas prices in California were attributed to several factors, including “supply and demand imbalances, the volatile electricity market and a lack of sufficient in-state generation sources — which interlinked to cause natural gas price spikes based on acceptable, but admittedly volatile market forces,” said the EPSA, which represents independent power producers, merchant generators and power marketers. Moreover, a severe hydroelectric shortage existed in the Pacific Northwest; gas deliveries to California were interrupted following a rupture on El Paso Natural Gas’ South Mainline system in New Mexico; intrastate storage of natural gas was at an all-time low; and California’s in-state pipeline system was constrained.

At the same time of the gas supply squeeze, “there was an increased demand for electricity from gas-fired plants — including some of the most inefficient plants — which created a situation where natural gas buyers had to offer price bids on the spot market high enough to ensure that they obtained the necessary natural gas commodity” to operate their facilities, the EPSA noted.

“Because of the complexity of the market forces at work, the well-documented physical factors severely affecting the California market; the lack of concrete findings of price manipulation by the Commission or Commission staff, and the advanced stage of the California refund proceeding, EPSA urges the Commission to retain its initial method used to determine the cost of natural gas to be used to calculate refunds.”

Some companies argued the adoption of staff’s proposal would only serve to further drag out the power refund proceedings at FERC, and potentially could open up the floodgates for litigation by generators against their gas suppliers.

If FERC were to adopt staff’s proposal, “this would call into question all transactions relying upon published indices, and may very likely discourage parties from using this well-established means of effectuating transactions,” contends the Public Service Co. of New Mexico (PNM). “The only ‘merit’ of the staff’s proposal is political; it artificially increases the refunds that will be deemed due from suppliers.”

Staff’s recommendations would have “significantly adverse consequences” for liquidity in the electricity markets in the West and elsewhere in the United States, which already have been “threatened” by an almost across-the-board loss of trading functions over the past months, PNM noted.

Mirant Corp. pointed out the recent staff proposal conflicted with a staff report issued in 1989, which was precedent-setting in backing up the use of published prices. The earlier report was the result of an in-depth study of the gas prices of four publications, including the three used in the FERC formula. It found that “delivered price indices reflected the competitive price of gas because the reported prices responded to supply and demand.”

The 13-year-old study “concluded that the indices were reliable because they are in general agreement with each other and were representative of the spot prices in supply areas to which they refer. Given the same basic fact pattern, the current staff report reached the opposite conclusion and finds the similarity of prices to be evidence of collusion.”

The prior staff report pointed out that a well-functioning spot market should exhibit high prices during periods of weather-related increases in demand, and also when “demand for electricity peaks in the late summer, spot prices increase.” In contrast the current staff paper finds gas prices to be indicative of market manipulation, ruling out consideration of a scarcity-driven market.

“While the staff 1989 report admittedly is dated, it nonetheless is remarkable to contrast its comprehensive, reasoned consideration of the operation of natural gas commodity markets with the results-driven, narrowly-focused approach of the current staff report.”

Like the CPUC, the California Independent System Operator (Cal-ISO), which operates the state’s transmission grid, said it “believes that the evidence uncovered by staff as to the potential for manipulation, and possible actual manipulation, of California natural gas indices is highly convincing.” The FERC staff’s proposed action “confirms the [Cal-ISO’s] long-standing position that spot market gas price indices should not be used in determining refunds because of the dramatic irregularities in these price indices during the refund period.”

It urged FERC to clarify that gas-fired generators should only be allowed to seek recovery of demonstrated gas costs in the event they opt for cost-based — rather than market-based — rates during the 2000-2001 refund period. In addition, the Cal-ISO asked the Commission to impose “clear, stringent requirements for the calculation and allocation of gas costs before sellers seeking cost-of-service rates are permitted to recover costs in excess of the competitive proxy price for gas proposed by staff.”

It also asked the agency not to make any allowances for additional generator gas costs related to capacity scarcity. “Even if it could be determined with certainty that true scarcity of gas transportation capacity existed during specific days during the refund period, the ISO urges the Commission to avoid efforts to establish some ex post ‘scarcity rent.'”

While the staff proposal suggests there was scarcity of gas transportation capacity from producing regions to the California market during the energy shortage, the Cal-ISO contends the conclusion is “inconsistent” with Wagner’s ruling in the El Paso complaint case, which found there was “excess, unutilized” gas transportation on the pipeline during the period, and that El Paso withheld “substantial volumes” of capacity to border delivery points to inflate prices for natural gas, the grid operator said.

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