The onset of competition in Canadian natural gas transportation may have made the field riskier for TransCanada PipeLines, but not by enough to persuade the nation’s principal regulator, the National Energy Board (NEB), that the change justifies rich compensation. The NEB handed down a long-awaited verdict on effects of industry upheavals since the late 1990s, concluding that the pipeline deserves a 2% raise in rates rather than the 12% increase it had requested.

Rather than revolution, the word for the change should be evolution, the NEB ruled. The board, saving gas shippers from added costs measured in the hundreds of millions of dollars, rejected TransCanada’s request for a thorough overhaul of its finances. The aborted plan called for a C$265 million/year (US$175-million) raise for TransCanada that translated into a C$0.13/gigajoule (US$0.09), or 12% increase in the system’s benchmark “eastern zone” or long-distance toll, to about C$1.26/gigajoule (US$0.80 per MMBtu). The NEB instead granted TransCanada about one-eighth of its request: a 2% raise for its rate of return, achieved with a technical adjustment, projected to be worth C$30 million (US$20 million) a year.

The NEB held the pipeline’s allowed rate of return down to 9.61% for 2001 and 9.53% for this year, levels set by a 1990s formula established after lengthy review and negotiations with shippers. The modest raise was generated by applying the rate to an increased amount of deemed equity ownership of the delivery system as opposed to the share financed by loans: 33%, up from 30%.

In response, TransCanada confined itself to a terse statement that it was “disappointed,” but it said there would be “little impact” on its financial results. Shipper groups, led by the Canadian Association of Petroleum Producers, said the decision was a relief. Sources in both camps privately indicated the disappointment was deep among Canadian pipelines and the relief was great among shippers.

During lengthy NEB hearings on TransCanada’s proposal, both sides described the case as a landmark liable to have ripple effects across the gas industry. Transporters voiced hope that the NEB would create a new regime enabling them to improve their rates of return. Shippers viewed the TransCanada case as bound to start a domino-effect series of toll increases.

The Canadian Gas Association, primarily a voice of distributors and closely aligned with the long-distance pipelines, told the NEB that all transporters deserve a new regime because their operating environment is increasingly competitive, both to attract investment and deliver services. On the shipper side, Coral Energy Canada Inc. (an arm of the international Shell organization), for instance, called TransCanada’s proposals a “watershed application.” Coral predicted that if TransCanada won, the board could count on seeing “a parade of pipeline applications” for similar increases on all long-distance delivery systems and distributors would likewise line up for raises before provincial public utilities commissions from British Columbia to Ontario.

The NEB ruled that the market for transportation services had not changed enough to let TransCanada introduce a new method of calculating its revenue entitlement called ATWACC, or after-tax weighted-average cost of capital. TransCanada devised the method as compensation for the arrival of new gas routes, chiefly Alliance Pipeline between northeastern British Columbia and Chicago plus allied alternative service to markets farther east in Canada and the United States.

The NEB found that complete absence of agreement with shippers on TransCanada’s proposal stood out as evidence that it fell short of fulfilling requirements for making a big change. It was neither “transparent” nor understood. The scale of the raise that ATWACC would have given TransCanada was not justified by the facts of pipeline life as they emerged from lengthy hearings, the NEB said. “There has been no ‘new paradigm of constructing pipeline capacity in advance of supply,’ as suggested by one of TransCanada’s witnesses.” Instead, there has been “natural evolution of the pipeline industry and the integration of competitive forces into the board’s decision-making,” the ruling said.

The NEB said “the risk” of running partially empty “arising from the (TransCanada) mainline’s increased exposure to competition is mitigated by a number of factors. The mainline is the largest pipeline leaving the Western Canada Sedimentary Basin and a substantial portion of its customers, both end-users and producers, are captive and are expected to remain captive to the mainline for the foreseeable future.

“TransCanada has increased its ownership interest in pipelines leaving the WCSB, which would tend to reinforce its market power…a substantial share of capacity addition leaving the WCSB was constructed by pipelines in which TransCanada has an ownership interest.”

In awarding TransCanada its modest raise, the NEB said the pipeline faces a new element of “competition risk,” as shown by a reduction in the average length of its long-term shipping contracts to five years from eight years in 1994. About 1.7 Bcf/d or 23% of the mainline’s 7.3 Bcf/d capacity operates on short bookings after non-renewals of long contracts. TransCanada told the NEB that another 3.2 Bcf/d in long contracts expire over the next five years.

In limiting TransCanada’s raise, the board pointed out that the evolution of the gas industry is far from complete and the pipeline still has chances to adapt, plus built-in advantages owed to its size and maturity. The age of the half-century-old TransCanada system will eventually, thanks to depreciation and reduced revenue requirements on the financial side, give it “flexibility in meeting the challenges of competition,” the NEB said.

“As well, having some excess capacity may provide the Mainline with a competitive advantage for capturing incremental supply and may allow it to achieve throughput levels in excess of contracted capacity through the provision of short-term discretionary services.” TransCanada is scheduled to complete negotiations with shippers and submit a proposal for a new regime of competitive services to the NEB this fall.

The NEB pointed out that TransCanada’s own experts do not accept gloomy predictions that gas supplies will fail to catch up with all the new long-distance pipeline capacity built since the late 1990s. The board acknowledged that the rate of supply growth in established production regions of the western provinces has slowed down, amid growing demand for gas for their own industrial expansion, such as oil sands projects. But the threat that gas shipments to central Canada and the U.S. will deteriorate, leaving the TransCanada system under-used, remains “modest,” the NEB said. The board pointed out that new gas sources are emerging.

The NEB said the risks that TransCanada will wind up running part-empty as a permanent condition “are partially mitigated by an increase in the probability of development of frontier resources, as shown by the renewed interest in Arctic gas supplies from the Mackenzie Delta and Alaska, and the recent development of unconventional resources — for example, coalbed methane — from the Western Canada Sedimentary Basin…in this proceeding, the board notes that TransCanada forecast that both Arctic gas and coalbed methane will come on stream within the next 10 years.”

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