Can you trust a marketer with all of your regulated assets? It’sa question many LDCs are asking themselves these days asderegulation and competition are stranding more and more supplycontracts, upstream transportation and storage. But there’s no easyanswer, according to several panelists speaking at NGI’sGasMart/Power ’99 in Dallas last week.

Asset optimization clearly is not a one-size-fits-all solution,and outsourcing may not be the right strategy for every unbundlingdistributor. “Why do it? One reason would be to increase earnings,make more money,” Consolidated Edison’s Paul Olmsted noted. Butthat is by no means a sure thing.

“If you fully outsource you could get rid of many of the peoplethat performed that function and cut your costs a little bit.Smaller companies may not have the staff resources on hand orreally the scope of assets to really be able to effectively sellinto the marketplace and get the best return.”

That was part of the reason Providence Gas signed a totalupstream asset management contract with Duke Energy in September1997. So far, according to Tim Lyons, vice president of marketingand regulatory affairs for ProvGas, the arrangement has workedwell, but there are some aspects of the transaction that other LDCsmay wish to avoid.

“The key issue that we were faced with was the issue of pricevolatility,” said Lyons. “We had over the prior three yearsexperienced tremendous volatility. We had a [gas cost adjustment]mechanism where basically the price we were charging customers wasthe Nymex price. So as the Nymex went shooting up so did ourprices, and as the Nymex went crashing down so did our prices. Andit was this volatility that created a lot of problems for ourcustomers and our regulators. We tried a couple of things. We trieda pilot hedging program to mitigate some of that, but we weren’tthat successful.” The small utility also had the difficult task ofmanaging 5.4 Bcf of working storage capacity, 1.5 Bcf of LNGstorage, 155 MMcf/d of firm transportation and an average of 20Bcf/year of gas supply contracts.

Providence Gas has a net income of about $80 million annually,but its gas supply costs are about $100 million “so even a 10% slipup in any of these [asset management] risks could wipe out ourearnings for an entire year so it’s very critical for us to managethose risks.”

There also were other reasons to go with a marketer given theright economics. ProvGas needed some extra revenue for old gas mainreplacement and an expansion into new economically attractiveareas. Meanwhile, regulators and legislators dealing with electricrestructuring were calling for a rate cut for both electric and gascustomers.

What the Rhode Island LDC came up with was a condensed formulafor all of its supply delivery needs that would provide a reducedand fixed rate for its customers in addition to the revenuesrequired for its system upgrade. Lyons described it as Nymex plusX, with X representing costs of delivery in addition to the purecommodity.

ProvGas then held an auction and granted the winning bidder,Duke Energy, an unprecedented deal that allowed total control overthe utility’s assets for three years. In return, ProvGas willreceive a promised savings of $75 million, allowing it to cutcustomer rates 5% ($28 million), freeze them over three years andmake $80 million in upgrades to its distribution system.

So far it has saved customers 4% off their bills and, accordingto Lyons, has encouraged competition because marketers like havinga fixed regulated rate to underbid in the retail markets. ProvGashas 14 marketers participating in its unbundling program, andcustomer savings have averaged 5-20%.

Other LDCs have jumped on the outsourcing bandwagon recently,including Brooklyn Union, which signed a $500 million, one-year gasmanagement contract with Enron, who promised savings of more than$10 million, 80% of which would go to ratepayers. And Sempra EnergyTrading agreed in January to manage the supply and delivery of gasto serve Southern Connecticut Gas Co.’s 158,000 customers,including 37 Bcf of supply, 4 Bcf of storage capacity and 162MMcf/d transportation capacity.

But ConEd’s Olmstead issued a warning to LDCs who may bethinking about handing all their assets to marketer. “You’reentrusting the delivery of gas to another company who does not havethe same interest in maintaining that reliable supply that we do…We’re the guys with the matches. If the gas doesn’t come to thecitygate, we’re the guys who have to re-light all the pilot lights,and I can assure you that re-lighting a million pilot lights in NewYork City would be a horrendous undertaking.”

Olmsted pointed out that none of these new outsourcing deals”have been tested by a really cold winter like we had in 1993-94 oran exceptionally high-priced winter like a couple of years afterthat. We’re all praying for a return to normal weather, but if itgets really cold we just don’t know how things will work.”

Another problem is that with total asset optimization it’s”pretty much irrevocable,” he noted. “Once you go whole hog, youcan’t go back because you’re going to disperse the folks who havebeen doing it, and you’re going to lose the expertise.” ProvGas’Lyons conceded the LDC probably will not be managing its ownsupply, transportation and storage assets again any time soon.

The deciding factor, according to Olmsted, is the risk of makingless money. “If it’s an all-or-nothing thing, you have a lot tolose.”

ConEd has done some partial outsourcing, sharing assets withmarketers and splitting the results. But many times the benefits ofthese deals aren’t worth the trouble, he said.

“In other cases what we’ve found is the activity of the marketerhas not actually increased the value to us. It’s possible that amarketer with national scale is putting our asset into this bigpicture, and if they do that, theoretically they can generate morevalue than I can. The problem has come after that in many cases,”with marketer transaction fees and revenue sharing.

“I would never say never about doing the whole thing because theworld could change and we might find that someone does give us morevalue than we can generate on our own. But when we look at ouroverall strategy for maximizing our bottom line and minimizing thecost of gas to our customers we look at outsourcing as one of manytools” and not the only solution for the changing needs of the LDC.

Rocco Canonica, Dallas

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