Fortnightly
Steel in the Ground
October 15, 1995By Bruce W. Radford
And wires in the air. Together they form the interstate natural gas pipelines and the electric transmission grid. When the talk turns to deregulation, whether on the gas or the electric side, the pipelines and the transmission grid are almost always voted "most likely to." That is, to remain regulated monopolies \(em with cost-of-service rates protected by the Federal Energy Regulatory Commission (FERC).
Let's have a look at that idea.
The FERC has unbundled gas commodity sales from pipeline transportation. It touts Order 636 as a triumph. Even so, many gas pipelines are reeling. They won the "right" to recover all their fixed costs through the straight fixed-variable (SFV) method, but someone forgot to ask shippers what they would pay to wrap their gas in steel.
Today, the "monopoly power" in the pipelines that underlay Order 636 is looking a little less than firm. "Decontracting" and shrinking throughput threaten the finances of certain pipelines, especially out West. Released pipeline capacity is trading on a "gray market," apparently to sidestep the FERC's regulatory price ceiling in the secondary market. Why? Unbundling has exposed inefficiencies in gas transportation. Computers and real-time information have turned the pipes inside out, and gas "basis" upside down. It has taught shippers, marketers, and local distributors how to buy more gas with less steel.
Now, the wires business comes to bat. Flushed with victory on the gas side, the FERC wants to do for electrics what it did for gas: It would unbundle the vertically integrated electric utilities to insulate the generating sector from monopoly power in electric transmission. It envisions a regulated grid with cost-based rates to recover transmission "revenue requirement," and perhaps a surcharge for stranded investment. The structure would more or less follow the gas pipeline example.
But how much market power can the wires command? What if the electric "shippers" back out of their firm transmission contracts, as their gas counterparts are now doing? Power traders might come to prefer short-term nonfirm transmission. If that happens, how long can transmission providers hope to exact embedded-cost rates, let alone a surcharge tacked on to recover admittedly uneconomic costs from generating plants \(em an entirely different business.
Touch Football
In September I ran into Phil Marston, who graduated a year ahead of me at Yorktown (Arlington, VA) High School, and who I had last seen sometime around 1965, in a neighborhood touch football game. In grade school I followed him as a co-captain in the school safety patrol. These days, Marston holds the position of vice president, regulatory affairs, for Hadson Gas Services Inc., at the company's Washington, DC, office.
At Hadson, among other things, Phil has been assembling data nationwide on gas pipeline capacity release. He can tell you, up to a month or so ago, how much capacity shippers have released on each pipeline, in what size chunk and in how many separate transactions. Working with that primary data, Phil has developed a few ideas on the gas pipeline capacity market:
"The risk of holding [pipeline] capacity that you don't need has gone up. And the likelihood of being made to pay for a mistake has gone up. But the need for holding capacity has gone down, [since] you can trade information for steel."
To put the problem in perspective, Marston explains: "In the past the LDCs [local distribution companies] in effect 'resold' capacity in bundled rates at the burnertip. But the term 'LDC' is a misnomer. They are [really] gas marketers."
Another problem, however, is that the FERC has barred shippers from brokering capacity \(em instead forcing them to release capacity back to the pipelines \(em but at the same time continues to regulate gas transportation rates so that pipelines sell firm capacity at FERC-regulated SFV rates, designed to recover all fixed costs. The result, according to Washington, DC, attorney Sheila Hollis, is that "the secondary capacity market has taken on a 'shadowy' nature that was not envisioned by the FERC." A "grey market" has developed in which gas supply and pipeline are packaged together in prearranged deals, making it impossible to discern the capacity price from the commodity price. The lesson? Competitive markets do not necessarily favor bundling or unbundling. They want flexibility.
"The gas industry is driven by flexibility," says Mark Schroeder, vice president and general counsel at Northern Natural Gas. As he sees it, "LDCs are looking for a flexible portfolio of flexible service providers \(em but the pipelines can't provide it. If you want vanilla, the pipelines have it. You can have any rate you want, as long as it's SFV."
Monopolies Out There
Not everyone is chagrined that the FERC continues to regulate gas pipeline transportation rates, without granting market-based rates as it has done for electric generation, except, perhaps, for a recent case involving Koch Gateway Pipeline, as reported in Gas Daily, Sept. 14, 1995.
Katherine Edwards, from the Washington, DC, law firm of Travis & Gooch, points out that we still have the Natural Gas Act, which bars discriminatory rates. A comment filed last April on behalf of gas shippers (FERC Docket No., RM95-6-000, Alternatives to Traditional Cost-of-Service Ratemaking for Natural Gas Pipelines), in which Edwards participated as Of Counsel, noted that the Natural Gas Act still imposes a "just and reasonable" standard, requiring rates to fall within a "zone of reasonableness," to balance investor and consumer interests. Moreover, "the FERC must ensure that market-based rates, if approved, are not unduly discriminatory or preferential."
Richard Morgan, an attorney with Lane & Mittendorf, Washington, DC, notes that the FERC expects to issue an order before October 1996 on market-based rates for gas pipelines.
"There are still monopolies out there," warns Edwards. "There are lots of methods short of market-based rates to achieve flexibility."
Editor
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