Capacity Release Rulemaking Needs Close Study

n a series of orders earlier this year, FERC I ruled that its Policy Statement permitting pipelines to negotiate rates with its shipper- customers did not apply to the secondary mar- ket. (The Commission defines this as released capacity, pipeline IT, and short-term firm.) Thus, neither pipelines nor releasing firm shippers (mainly LDCs) were free to enter into transac- tions that could result in the sale of capacity in the secondary market at prices exceeding the maximum pipeline tariff rate. The Commission so ruled in orders addressing several specific pipeline proposals.

On July 31, 1996, the Commission issued its long-awaited NOPR concerning the capacity release market and the secondary market in general.’ In a companion document (Docket No. RM96-14-001), the Commission announced a pilot program to remove the price cap for releases of capacity and sales of interruptible and short-term firm transportation in certain geographic areas. The Commission stated that it wanted to get the pilot program up and running in time for the 1996-1997 winter heating season.

The Proposed Rulemaking The Commission’s timing for its capacity

release rulemaking is hardly surprising. The D.C. Circuit gave the Commission a sweeping victory on all capacity release issues in its decision upholding (for the most part) Order 636.2 Thus, the court affirmed the Commission’s position that released capacity is indeed inter- state transportation of gas, subject to the Commission’s exclusive jurisdiction under the Natural Gas Act. This jurisdiction is regardless of whether or not the release is by an LDC to one

of its own customers behind its city gate. Thus, the Commission now felt free to examine the entire secondary market, confident of its right to deal with it as a whole (as it defines it).

er-customers

Following are the major features of the Commission’s proposal from the end user’s viewpoint:

1.

2 .

3.

Pipelines must treat all short-term transpor- tation comparably. This includes capacity release, pipeline interruptible, and pipeline short-term firm. The Commission will vigorously enforce shippers’ rights to segment their capacity for release purposes. It also raises the question of whether firm shippers should be allowed to segment their capacity even when they are not releasing capacity. At some point, the Commission will exam- ine restrictions concerning replacement ship- pers’ ability to change primary receipt and

Edward J, Grenier Jr. is a partner in the Washington, DC, law firm of Sutherland, Asbill & Brennan. He is also general counsel of the Process Gas Consumers Group and is president-elect of the Federal Energy Bar Association.

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delivery points. Particularly troubling are the provisions in some pipeline tariffs under which releasing shippers lose their rights at primary receipt or delivery points if the replacement shippers change primary points under the release.

4. Noting that only 25 to 31 percent of the transactions subject to the current bidding requirement actually involve competitive bids, the Commission, in response to re- quests from LDCs, is proposing to eliminate the bidding requirement. Perhaps of most significance for end users is the Commission’s proposal to remove price caps for secondary market transactions, if certain conditions are met. The releasing shippers and the pipelines would be re- quired to demonstrate that they are unable to exercise market power, and LDCs would have to demonstrate that they provide open- access transportation behind their city gates. The commission recognized that, regard- less of the number of firm shippers, LDCs may still exercise market power over cus- tomers behind their city gates. The Commis- sion also recognized that, in some situa- tions, the market may not be competitive because only one or a few shippers control firm capacity. And, finally, the Commission also noted that interruptible capacity, stand- ing alone, may not be a sufficient competi- tive alternative to released capacity, and the existence of the gray market is not a reason to remove price caps across the board.

5.

ransac condition

The real work on the price cap issue will be a determination concerning how to measure market power in the secondary market and what minimum criteria there should be for acceptable LDC open-access programs. Will the criteria laid out in the Commission’s Policy Statement (in RM95-6) about market-based rates for pipeline service apply with respect to the secondary market? Is it appropriate to include pipeline short-term firm and interruptible ser-

vices as part of the secondary market? (I believe the answer to that should be no.) How should short-term firm be defined? In the Order 636 context, the dividing line between short- and long-term firm service is one year. What about rollovers? When does short term de facto be- come long term?

Among the other questions that will have to be addressed when considering the price cap issue is what, if anything, should be done about the gray market?’ As noted, the Commission states in the NOPR that the existence of the gray market does not, in and of itself, justify the lifting of capacity release price caps across the board. However, the Commission does ask whether the lifting of caps would reduce reliance on the gray market. The Commission also puts all on notice that it might take punitive action against anyone in the gray market who does in fact violate transportation rate caps (e.g., by revok- ing that person’s certificate for the sale of gas for resale in interstate commerce). What the Com- mission wants to know is the alternatives that might be available to it for regulating both capacity release and the gray market.

Finally, concerning the cap issue, the Com- mission raises the question whether, as an alter- native to both the current situation and lifting price caps, the Commission might prescribe an overall annual revenue cap. Thus, the releasor could charge whatever it could get, so long as its annual revenue did not exceed the c a p w h i c h presumably would be the daily reseration fee times 365 days times the quantity of firm demand held.* If permitted, this would be tantamount to lifting the price cap on systems where released capacity is sharply discounted in the summer. Such a system could permit LDCs to exert market power at peak periods, completely unrestrained by the annual revenue cap.

The Pilot Program Notwithstanding its careful call for com-

ments about the conditions that would need to be met before price caps would be lifted for released capacity, the Commission, in its com- panion document, establishes a pilot program to be implemented for the 1996-1997 heating season (e.g., by November 1, 1996). The Commission‘s stated purpose is to gather evi- dence for evaluating market power criteria for the secondary market.

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Accordingly, the Commission invited pipe- lines and LDCs to apply to participate in the program in their own specific geographic areas. However, the program is not limited to specific areas of the country. Under it, the price cap would be removed for capacity released by an LDC to delivery points in its delivery area, for interruptible and short-term firm transportation sold by the pipeline into the same area, and for capacity released by other shippers into the area. While the Commission stated that it would require participating pipelines and LDCs to make showings that they cannot exercise mar- ket power in the relevant area, they need not make the detailed showing contemplated in the NOPR.

Some industrial end users protested the shortness

of time, and the Commission did extend the deadline

until October 4.

The Commission called for pipelines and LDCs to make their pilot program filings by August 30, 1996, although it indicated that later filings could be made. Initially, the Commission said that it would give protesting parties only 15 days to file their protests or to comment. Some industrial end users protested the shortness of time, and the Commission did extend the dead- line until October 4.

For whatever reason, relatively few pipe- lines and LDCs filed pilot program applications. As of this writing, the Commission has not made any decisions regarding those applications. I expect that it will definitely want to get at least some up and running in order to see how market-based rates for the secondary market might work in the real world.

Impact on End Users Industrial gas users have a huge stake in

both the rulemaking and the pilot program. Unfortunately, given the very limited amount of time before the Commission wishes the pilot program to be up and running, it is very likely that some applications will be granted in situa- tions that will not afford protection from exer- cise of market power by either pipelines or

LDCs or both. While such individual programs may ultimately yield some useful data, that benefit will not outweigh the damage that is likely to be done to market participants, particu- larly end users dependent on the secondary market.

It would be far better for the Commission not to rush into the unknown with the pilot pro- grams. Rather, it should gather the data andviews it is seeking in the rulemaking and fashion a program that will truly protect consumers (in- cluding industrial end users) from harm. For example, the Commission is proposing to in- clude pipeline IT and short-term services in the secondary market and apply the same rules to them as it applies to released capacity. However, pipelines can play games with short-term firm.

For example, there is one pipeline that offers a short-term product called recallable primary point firm. Because the service is lim- ited to primary delivery points, it will trump all firm capacity released to secondary delivery points. Because it is recallable, it is hardly true firm. What this means is that the pipeline, through manipulation of its tariff offerings, can distort the market and make the playing field very unlevel. Instead of turning the pipelines and LDCs loose through the pilot programs after, at best, minimal review of the applications, the Commission should examine the situation more thoroughly. It should weigh the evidence presented to it in the rulemaking; establish the rules; and then see, on a case-by-case basis, whether anyone qualifies to charge market- based rates in the secondary market. Only in this way will consumers be protected.

Notes Seconda y Market Transactions on Interstate Natural Gaspipelines, Docket No. RM96-14-000 (July 31,1996).

UnitedDistribution Co. u. FERC, 88 F.3d 1105 (D.C. Cir. 1996). Transactions in the gray market involve sales of rebundled gas and pipeline transportation. Effectively, there is no price cap because one part of the transaction (the gas commodity) is not subject to price regulation. Thus, if the maximum transportation rate is $0.75 (at 100-percent load factor) and the bundled price per MMBtu is $10.00, the seller will claim that it is not exceeding the max transportation rate-it is simply selling the gas itself for $9.25! While this may look a bit suspicious if the going gas price appears to be $2.25, there is nothing illegal on the face of the transaction.

E.g., $8.00 x 365 x 10,000 MMBtu.

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