The first battle over covering the expense of excess capacity generated by the onset of competition in the Canadian natural gas delivery grid has been won by TransCanada PipeLines Ltd., but the war is far from over. The National Energy Board (NEB) rejected a salvo of proposals to make TransCanada absorb half the costs of empty space in its system, setting the stage for toll increases on the remaining customers, with the amounts to be determined by another case now developing. However, the board also declared that its decision to uphold the status quo is temporary.

The NEB directed TransCanada to try again to negotiate a cure for the overcapacity headache and directed the company to submit a fresh blueprint for its relationship with its customers by Sept. 1, 2002. The rejected cost-sharing proposals came from two groups of TransCanada customers: a combination of PG&E Energy Trading Canada Corp. and El Paso Merchant Energy Group, and the Cogenerators Alliance of Cardinal Power of Canada LP, Lake Superior Power Limited Partnership, Tractabel Power Inc. and TransAlta Energy Corp.

The groups say they are adversely affected by toll increases and it would be fair to make TransCanada accept financial responsibility for the vacated space in its system that drives the hikes. The NEB acknowledged that TransCanada, as Canada’s biggest and most established pipeline, has taken punishment from the onset of competition in the Canadian gas transportation sector. The opening a year ago of the new Alliance-Vector system — an alternative route stretching from northeastern British Columbia to central and eastern Canada and the United States — triggered an immediate drop in commitments to use TransCanada. It took the form of non-renewals of long term contracts for firm transportation service, a former pillar of the Canadian gas industry.

By late 2000, the non-renewal wave rose to about 1.5 Bcf/d or nearly 19% of the capacity in TransCanada’s mainline. Non-renewals continued this fall, with the Oct. 31 end of the contract years for gas sales and deliveries. By Oct. 31, 2002, evidence before the board indicated that the total of lost transportation contracts could reach about 2.7 Bcf/d, or more than one-third of TransCanada’s capacity.

The NEB ruled that TransCanada’s critics failed to prove it did anything blameworthy enough to be penalized by swallowing costs owed to construction of other pipelines. The decision said, “Absent clear evidence that TransCanada has been imprudent or that its actions have caused contract non-renewals, the board is not inclined to impose, after the fact, the financial impact of the realization of a risk that TransCanada has not traditionally borne.”

The NEB found that “no party provided compelling evidence supporting the view that TransCanada’s actions have caused contract non-renewals or have contributed to their severity. On the contrary, most parties, “including the Canadian Association of Petroleum Producers,” acknowledged that the majority of contract non-renewals resulted from shippers opting to ship gas on competing pipelines.”

TransCanada and its customers have become victims of a lag between increased pipeline capacity and additions of gas production capacity needed to fill up the grid. Exactly how the decision to uphold the status quo, “cost-of-service” method of determining the revenues that TransCanada deserves will translate into new shipping rates remains to be seen.

A second major toll case is under way. Scheduled for hearings this winter, the further review centers on a TransCanada application for a major overhaul of its permitted rate of return. Evidence before the NEB shows that TransCanada’s tolls are on their way up sharply, compared to mid-2000 rates if the pipeline wins all that it seeks. The allowed annual rate of return will jump to 12.5% from 9.6%. Benchmark “eastern zone” tolls, to ship gas from the West to central Canada and export points there, will rise to C$1.25 per gigajoule (US$0.87 per MMBtu) for 2001 then go up again to C$1.285 (US$0.90) in 2002. Compared to the mid-2000 rate of C$1.009 (US$0.71), the new tolls represent a 28% increase by 2002.

The opening decision in the complex capacity and toll cases made it plain that TransCanada cannot rely on regulatory traditions built up in the old days of pipeline monopolies to protect it forever from competition. The ruling said, “For the longer term, the Board shares the view expressed by many parties that a review of TransCanada’s business and regulatory framework is necessary. The Board is encouraged by the commitment of most parties to negotiate, over the next few months, a future business and regulatory model for TransCanada. Accordingly, the Board has high expectations for these negotiations and trusts that all stakeholders will participate in good faith.”

The ruling indicated the NEB intends to have an open mind on the future of pipeline rates. Possibilities that the board said it is willing to consider include “term-differentiated tolls” (discounts to reward long shipper commitments) and a negotiated risk-sharing system to cover costs of excess capacity.

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