Patrick Crow
Washington Editor
A. D. Koen
Gulf Coast News Editor
There is no turning back for U.S. interstate gas pipelines preparing to begin operations this winter in a gas market set loose by federal mandate.
Most interstate pipelines are well on their way to complying with Order 636, issued in 1992 by the Federal Energy Regulatory Commission as the final step in deregulating U.S. gas markets to enhance competition. But the process is not without problems.
FERC Chairman Elizabeth Moler contends old federal rules governing interstate gas transportation won't work in a more competitive industry. And FERC staff is pressing ahead with several hundred technical conferences with pipelines to realign all gas transportation companies with Order 636 by a Nov. 1 deadline.
Order 636 requires interstate pipelines to cease offering merchant services to gas customers. In effect, they are allowed to deliver gas but not own it. So end users must buy gas directly from producers, aggregators, or marketers.
The pipelines are to unbundle transportation services and charges, restructure operations, and be ready to tailor services to fit each transportation customer's needs by the 1993-94 winter heating season.
Stan Horton, president and chief operating officer of Enron Operations Corp., Houston, said the gas industry needed FERC's order to speed the evolution of interstate pipelines into pure gas transportation and storage providers.
"We were in between the old regulatory scheme and where we needed to go," Horton said. "We're glad the commission issued the order and accelerated the timeframe, because it allows us once and for all to get the transition behind us. But pipelines would have completed the transition, even without 636."
However, not all U.S. gas industry participants welcome the more competitive gas market.
Various parties are challenging Order 636 in federal court suits.
As of early August, FERC had approved compliance filings by 35 interstate gas transporters but still was negotiating compliance proposals with 41 interstate lines and had not considered unbundled rates proposed by one other, Superior Offshore Pipeline.
LINGERING FEAR
Even among pipelines ready to function under FERC's new rule, there is lingering fear about how changes wrought by 636 will work.
Because each interstate gas pipeline system is unique in terms of configuration, capacity, and supply and market areas, each will be affected differently by Order 636. Correspondingly, each pipeline has had to respond in a unique way to fulfill the order's requirements.
As a result, no one is certain the new federal rule will allow pipelines to provide the services needed to move adequate gas supplies to customers on days of peak gas consumption. Some industry officials warn that brief disruptions of gas service could occur during cold weather this winter, as gas producers, marketers, transporters, shippers, and end users begin fine tuning operations on the U.S. interstate gas transmission grid.
Tom Miller, vice president of operations management for Coastal Corp.'s ANR Pipeline Co., Detroit, said the U.S. gas industry is committed to do as much as possible to assure adequate gas supplies during heating season peak demand. As an example, he cited the Natural Gas Council conference to occur this month in Chicago, where major pipelines and local distribution companies (LDCs) will mull ways of ensuring interstate gas transportation functions smoothly under Order 636.
While determined to press ahead with gas industry deregulation, Moler has postponed until next year two other gas pipeline incentives, one revising construction rules and the other offering incentive ratemaking.
Moler said the commission likely will issue some "second generation" orders next year to repair problems that arise after pipelines begin restructured services.
Given FERC approvals of restructuring plans, all interstate pipelines contacted for this story said they will have fundamental changes in place to begin operating under 636 by Nov. 1. But the deadline more represents a common starting point for further restructuring than the end of the U.S. interstate gas transmission industry's evolution.
ELECTRONIC BULLETIN BOARDS
FERC also has been working on the problem of how to establish an electronic bulletin board (EBB) network for the gas market, as dictated by Order 636.
The agency has named an EBB task force, with representation from all segments of the industry, to help it set parameters.
Robert Hauptfuhrer, chairman and CEO of Oryx Energy Co., has predicted, "EBBs may become the foundation for an integrated electronic data interchange system. Within such a system, anyone with a personal computer will be able to tap into a network for the very latest information required to transport gas.
"Available routes, suppliers, service options, and costs will be accessible in an instant. This network will make buying gas easier than ever before."
Nicholas Bush, Natural Gas Supply Association president, said EBBs could become an "information bonanza" to help gas buyers and sellers "understand exactly where natural gas contracts, deliveries, and payments stand."
However, some pipelines have balked about providing as much information about their systems on the EBBs as producers and end users want, and there have been problems developing a standardized format.
Bush said voluntary industry groups have developed an EBB data format and computer protocol, but no pipeline has completely implemented them during the past 5 years. He said FERC's intervention is essential if the system is to be uniform.
The cost of implementing requirements of Order 636 is an area frequently criticized by opponents of gas industry restructuring.
By forcing interstate pipelines out of the gas merchant business, Order 636 forced a host of potential transition costs on the pipelines. FERC said pipelines could recover from new rate structures, included in transmission company restructuring, costs incurred in shifting to a purely transportation and storage role.
FERC has estimated pipelines' transition costs at $4.7 billion, of which $3.2 billion is for gas supply realignment (GSR) costs. In June 30 orders for Texas Eastern Transmission Co. (Tetco) and Algonquin Gas Transmission Co., the agency set a procedure for handling GSR costs.
The cases raised the question of how to determine if GSR costs were incurred because of Order 636 and thus whether the pipeline should be allowed to recover 100% of them. They also raised the question of how to determine if GSR costs were prudently incurred.
FERC decided its staff should convene a technical conference in the cases, receive information from the pipelines and their customers, and report back to the full commission.
Although FERC also will examine GSR issues on a case by case basis for other pipelines, its decisions in the Tetco and Algonquin cases will set a general precedent.
In another area of dispute, Moler notes FERC has allowed pipelines to retain some upstream line and storage capacity in initial 636 filings but says the commission will take another look at that issue next year.
ANR's Miller said it is in the interest of everyone in the U.S. gas business to reduce transition costs as much as possible.
"That's been (ANR's) goal, and we've been fairly successful at it," he said. "My understanding is other pipelines have had the same general goal and have had similar successes."
GAO REPORT
Various congressmen have been concerned about the transition costs of Order 636 and the wisdom of the action, but the General Accounting Office (GAO) recently came out in favor of FERC's rule (OGJ, July 19, p. 27).
The generally supportive GAO report disagreed with some of FERC's cost estimates, however.
GAO said Order 636 could shift about $1.2 billion/Near in pipeline companies' fixed costs, about 11% of such costs, to LDCs and their end users, particularly residential customers.
GAO said, "Our estimate is $400 million higher than FERC's estimate of $800 million primarily because we used what we believe to be more appropriate assumptions about LDCs' purchases of interruptible service and discounts of such service by pipeline companies."
It said "Industry analysts agree It said, that certain aspects of Order 636 are needed to continue the increases in efficiency and competition achieved by previous statutory and regulatory initiatives. However, estimates of Order 636's benefits cannot be made with certainty until the order has been implemented.
"FERC estimated the benefits (accruing from Order 636) will exceed the costs by $2.1-6 billion/year on average. Although Order 636 may produce net benefits, we question FERC's estimate because it is based on various independent projections of increased gas use that did not consider Order 636."
A DAILY BUSINESS
David Jewell, general manager of marketing operations for Tetco, Houston, said Order 636 is transforming the U.S. gas industry from a monthly into a daily business.
Tetco is one of four Panhandle Eastern Corp. (PEC) interstate gas pipeline subsidiaries. Three of the companies have implemented Order 636: Panhandle Eastern Pipe Line o. on May 1 and Tetco and Algonquin on June 1. PEC's Trunkline Gas Co. expects to implement Order 636 on Sept. 1.
PEC last March formed 1 Source Corp., a nonjurisdictional subsidiary offering gas transportation services through PEC's interstate pipelines to customers in supply and market areas. The PEC unit within the month announced plans for:
- Flex-X a 10 year, 700 MMcfd expansion program to serve gas markets in the U.S. Northeast.
- Minuteman gas delivery system to serve U.S. Northeast electric power producers and LDCS.
1 Source in July held an open season for firm transportation beginning in November 1995 under the Flex-X expansion program. The open season netted Tetco firm service nominations totaling 18 MMcfd from receipt points located at Oakford, Pa., to northeastern utilities Philadelphia Electric Co., UGI Utilities Inc., Brooklyn Union Gas Co., and Elizabethtown, Pa., Gas Co.
To move the gas, Tetco agreed to lay 9.3 miles of loop pipeline at a cost of $18.1 million. Construction is to begin in June 1994, with completion expected Nov. 1, 1994.
Tetco in May 1993 implemented its Order 636 capacity release program for June customers using its Link integrated EBB. Tetco describes Link as a comprehensive electronic information system that allows on line management of gas business transactions, from nominations at the wellhead through delivery, billing, and accounting.
Tetco has organized its interstate pipeline system into operational segments and access and market tariff rate zones (see map, p. 19). Tetco customers can use 1 Source's Link EBB for point to point or zone express capacity releases and trades of firm transportation and no notice firm transportation, as well as bundled and unbundled firm storage.
NEW CONTRACTUAL RELATIONSHIPS
After several months of operating under Order 636, Tetco's Jewell said pipelines' electronic information systems likely will create opportunities to provide a wide range of other new services.
Already, a shipper can arrange quickly all needed transportation elements using EBBS. Soon, perhaps within the next few years, shippers will be able to buy and sell gas using only EBB transactions, Jewell said.
"In many ways, interstate pipelines have gotten into the information business, as well as in the gas transportation business," he said.
Even at this early date, electronic data systems have begun providing customers with information never before available. The evolution is creating new responsibilities for pipelines as well as for LDCS.
Jewell said many large LDCs now are responsible for purchasing their own gas and managing transportation and storage capacity. With pipeline supplies no longer available under Order 636 for unexpected incremental demand, LDCs will have significantly more management risks. But as they become more familiar with pipeline EBBS, LDCs likely will become more adept at using the information to increase control over their businesses.
To operate under Order 636 as a daily, information based gas transportation business, Tetco has been developing new direct contractual relationships between entities on either end of its interstate pipeline system.
Under the new contracts, if a company doesn't live up to its delivery or receipt obligations, it becomes responsible for cash out payments included as part of Tetco's 636 tariff.
TENNECO'S ELECTRONIC DATA
Tenneco Inc. unit Tenneco Gas, Houston, unveiled its computerized gas transportation system in March.
Customers can use the Tenn-Speed 2 system with a 486 personal computer with 8 megabytes of memory loaded with Microsoft Windows software to line up transportation or storage capacity on Tenneco's gas pipeline network.
Tenneco markets Tenn-Speed 2 through its Energy Tracs Inc. transportation resources and computer systems unit, announced in April. Energy Tracs offers contracting, nominating, scheduling, allocation, billing, and storage systems, as well as an EBB and capacity release program.
Tenneco said Tenn-Speed 2's electronic capacity release program provides a forum where users can release space, bid on capacity through open auction, and post contract awards. Following contract award, the system automatically amends all affected contracts so they are available for immediate nomination.
Tenn-Speed 2 users can input meter to meter nominations with customer routing, bill on scheduled volumes, and balance gas injections and deliveries. The system schedules and allocates gas volumes and posts differences in physical flow to applicable balancing agreements. Nominations are automatically confirmed and matched.
Tenn-Speed 2 is to officially begin operating Sept. 1. That also is the Order 636 implementation date for Tenneco's Tennessee Gas Pipeline and Midwestern Gas Transmission units. Tenneco's East Tennessee Natural Gas unit won't know until later this fall when it will implement 636. Kern River Gas Transmission Co. - of which Tenneco Gas is part owner - implemented 636 on Aug. 1 and will join other Tenneco interstate pipelines Sept. 1 in using Tenn-Speed 2.
In its 636 compliance order for Tennessee Gas, FERC approved mandatory operational balancing agreements (OBAs) for delivery or market area meters, but deferred approving OBAs for pipeline interconnect and receipt meters. Without the flexibility provided by mandatory production area OBAS, Tenneco must reinstate scheduling penalties and cash out mechanisms for shippers, Tenneco Gas Chairman and Chief Executive Officer Bob Thomas said.
While calling for a FERC technical conference to rehash questions pertaining to mandatory OBAS, Tenneco said most production area customers likely will sign voluntary OBA agreements because they streamline the settlement process.
TETCO'S TAB I & TAB II
Under Order 636, Tetco customers can balance daily pipeline injections and withdrawals with the help of two types of transportation, aggregation, and balancing agreement (TAB) between Tetco and gas suppliers.
TAB I agreements apply to normal operating activity. TAB II agreements are implemented in cases of radically altered demand. Each has its own rate schedule.
Firm transportation customers can obtain rights to capacity on Tetco's system down to the pipeline segment. When a shipper nominates from a TAB point in a given area, the TAB holder receives a right to move gas in that segment of the line.
Entities executing TAB I agreements essentially are allowed the right to aggregate and transport gas to a specific pooling point in a Tetco tariff rate zone. The TAB I holder can sell gas to a long haul shipper without the long haul shipper accruing responsibility for receipt imbalances. Subsequent imbalances are worked out directly by the pipeline and the TAB I holder.
"We think TAB I significantly improves flexibility for a long haul shipper whose main concern is to move gas from the access area to market," Jewell said. "It also allows the aggregator to specialize in buying and aggregating gas and managing imbalances, and as a result to provide a service to the downstream shipper."
In June, when Tetco began offering TAB I agreements, about 72% of the pipeline's transportation volumes were nominated at TAB I receipt points. In July, about 87% of transported volumes were nominated at TAB I points.
Jewell said that indicates the concept has been well received. Long haul shippers are taking advantage of the flexibility to avoid imbalances and are finding sufficient suppliers to act as aggregators and work with the pipeline to manage the imbalances.
TAB II AGREEMENTS
Since interstate pipelines can't own gas for resale under Order 636, TAB II agreements provide a way of packing Tetco's pipeline system ahead of expected increases in demand.
"When the pipeline calls for additional line pack, a TAB II holder can voluntarily put that gas into the line without a nomination from a specific end user," Jewell said. "That allows the TAB II party to sell gas on the fly after it is already in the pipeline."
Tetco benefits from the additional line pack, and long haul shippers can buy gas already on the way to market. AlSo, since Tetco's TAB II agreements are voluntary, a TAB II holder is allowed more lenient balancing requirements.
"Should the end of the month come before the TAB II holder can balance deliveries and sales, he has an extra month to sell the gas that's in the pipeline system to get back into balance," Jewell said.
A Tetco TAB II agreement was put to the test several weeks ago, when a series of rainstorms interrupted gas production at several platforms in the Gulf of Mexico.
Jewell said an operating company holding a TAB II agreement saw that some of its offshore gas wells were in the path of the storms and realized it would have to begin pulling personnel off platforms a day before evacuations began and gas began going off line. As a result, the company was able to serve its markets by replacing about 230 MMcfd of lost offshore supply with gas preinjected onshore in anticipation of problems.
"That was an example of a successful implementation of a TAB II arrangement that functioned exactly as we hoped it would when we designed the service," Jewell said.
TRANSITION COSTS DIMINISHING
Compared with early estimates, current projections of interstate pipelines' expected Order 636 transition costs have been sharply reduced.
Robert W. Best, president and chief operating officer of Transcontinental Gas Pipeline Corp. (TGPL) and Texas Gas Transmission Corp. (TGT), both subsidiaries of Transco Energy Co., Houston, said transition cost estimates are affected by such market dynamics as the status of unbundling at each pipeline, variations of spot prices, and the vintage of supply contracts.
Some cost estimates have diminished since FERC first proposed 636 because the commission's policies have become more clear. Some costs first categorized as transition costs either are turning out to be not extremely high or are being recovered not as transition costs but through normal ratemaking.
Best said GSR transition costs generally are calculated on the difference between spot and contract prices. Because spot prices have increased substantially since FERC issued 636, transition costs have been lessened by pricing dynamics.
In some cases, pipelines have reduced GSR costs because producers were willing to take back gas for which they had another market. In those cases there were no transition costs.
In other instances, companies based GSR costs on the presumption that Order 636 might be implemented in 1992. Since 636 instead is to go into effect in November, GSR costs attributed to contracts signed in the late 1970s or early 1980s-many of which were for 15 years-will be expiring in the next couple of years. Thus, for each delay in implementing 636, more contracted gas purchases can be honored, Best said.
TRANSCO'S GSR COSTS
Transition costs of Transco's affiliated interstate pipelines could vary considerably. TGPL had unbundled in a series of settlements with customers effective in August 1991. The settlements also resolved some take or pay issues and required TGPL to render some merchant services.
Best said because the decisions were taken in the past, associated costs already were passed through to customers or written off and could not be included under 636. However, FERC in essence has undone the merchant services settlement, which allowed Transco to collect above market costs through a gas inventory charge.
If FERC allows existing arrangements to stay in place, Best said, TGPL will have no transition costs. If the settlements are vacated, TGPL would have GSR costs of $100-150 million.
By comparison, TGT has remained a bundled pipeline, and its GSR costs, originally estimated at $225 million, have been cut to $100-125 million. Best said FERC is expected to let TGT's stranded upstream costs to be charged back to the wellhead, "so they're not going to be transition costs."
Although TGPL has been effectively unbundled for several years, it has received several extensions of its 636 compliance filing deadline because it has been negotiating the merchant service settlement. So while many of the information system refinements, measurement facilities, and other requirements of 636 already are in place and functioning on TGPL, the pipeline's new deadline was Aug. 4. TGT has until Aug. 15 to file its restructuring plan based on a July 16 FERC 636 order.
Both pipelines expect to begin operating under 636 effective Nov. 1.
ANR'S TRANSITION COSTS
Miller said ANR in January 1993 estimated its Order 636 transition costs at $80-275 million. It began whittling away at its transition cost exposure with a series of programs.
First, to help reduce costs of eliminating gas supply and upstream transportation contracts, ANR agreed to allow former sales customers a credit against transition costs if they would accept assignment of any supply or transportation contracts. ANR reasoned that, since supplies had been aggregated into a portfolio specifically for delivery by ANR, the pipeline should avoid paying producers to get out of contracts only to have former ANR sales customers to go out and buy the gas, effectively paying for it twice, Miller said.
After completing the reassignment process, ANR held reverse auctions to allow other people with realistic assessments of spot prices to take advantage of the supply. Since ANR didn't have much leverage because it had to get out of the contracts, if it tried to buy out a supply contract, the producer was likely to make unrealistically low projections of future spot prices to increase the buyout cost.
Miller said ANR discovered during an earlier restructuring spawned by FERC Order 528 settling take or pay disputes that "as soon as a date was set by which pipelines had to buy out a contract, the price of settlement went up."
So after the reassignment and reverse auction processes, ANR sought and got FERC permission to allow it to continue negotiating with producers while continuing to buy gas from them. ANR would take the gas, put it up for assignment to anybody who wanted to pay the market price for the gas, and direct bill its customers the difference between contract and spot prices as transition costs.
ANR effectively was continually reducing its obligation at the same time it was fulfilling its contractual agreement to take gas and was able to get some value out of the gas it was taking. "By doing that, we could run the contract a while longer and give ourselves more breathing room to get a decent settlement," Miller said. "The last thing we wanted to do was walk away from a contract that had some value."
In addition, when FERC issued Order 636, ANR had 1,200-1,300 gas supply contracts in Oklahoma with total combined volumes of 20 MMcfd.
The contracts were executed in 1978-82 and were nearing expiration. Since the total volume was small, transition costs shouldn't have been large.
"On the other hand, if you try to approach 1,200 interest owners about buying out their contracts, the costs balloon," Miller said.
So in its 636 compliance proceeding, ANR proposed running the contracts to their normal expirations and selling the volume on an EBB.
According to its proposal,"To the extent we had to pay under our purchase contracts more than spot market prices, we would charge that off as a transition cost," Miller said.
That mechanism also is slashing ANR's 636 transition costs.
ANR estimates the 1,200 contracts could have above market value of about $5 million but estimates the cost of terminating them at $40-50 million.
No final accurate estimate is available of ANR's total 636 transition costs. But Miller said the $80 million estimate in January was a best case scenario. Today it is the most reasonable case.
FEAR OF THE UNKNOWN
Pipeline company officials agree that the evolution of interstate gas transportation in the U.S. will not end when Order 636 becomes effective nationwide on Nov. 1.
But many say they have serious concerns about whether Order 636 will allow gas transporters enough flexibility to deliver adequate supplies during periods of peak demand.
"We as pipelines are committed to do as much as possible to make the system work under 636," Miller said. "But there's a lot of fear of the unknown among interstate gas pipelines. We don't know what's going to happen this winter."
Miller said general skepticism exists among gas producers about whether such 636 elements as operational flow orders really can be relied upon to the extent some theorize.
"Operators tend to be pragmatic and conservative, and then, don't trust anything they've never seen work before," he said. "In the meantime, we are trying to get together with them to see what we can do to iron out some of the wrinkles that could occur."
Transco's Best said FERC is likely to approve by the implementation date the balance of pending 636 compliance plans filed by U.S. interstate gas pipeline companies, "because it's so committed to the Nov. 1 deadline."
Similarly, interstate gas pipelines likely will have the required operating systems and contractual relationships in place. "We're going to have the fundamental changes in place, enough systems in place to make it work," Best said. "But Order 636 isn't something we're going to do on Nov. 1 and be done with it.
"This is going to require constant communication with our customers."
As promised by Chairman Moler and other FERC commissioners, many issues raised by 636 will be revisited. In addition, pipelines will have to continue improving their transportation and communications instrumentation to get better information and make refinements based on operating experiences. "Honestly, I'm not sure we know all the refinements we'll eventually have to make," Best said.
One thing is certain, he said: producers, aggregators, marketers, shippers, interstate pipelines, and end users must make Order 636 work for the good of the gas business. "Above all," he said, "we've got to make sure deliveries take place in a reliable, timely manner and in cold weather."
Copyright 1993 Oil & Gas Journal. All Rights Reserved.
