El Paso plans to resolve turnback dilemma

El Paso Natural Gas Co. has proposed a settlement designed to resolve its problems with California customers turning back much of its interstate gas pipeline capacity.

El Paso filed a comprehensive rate settlement with the Federal Energy Regulatory Commission negotiated with and supported by customers representing about 95% of its firm pipeline capacity. FERC is expected to approve the settlement by late summer.

A positive sign for the settlement was a statement of support from El Paso's biggest customer, Southern California Gas Co.

On Jan. 1, SoCalGas reduced contract demand from El Paso by 300 MMcfd. Together with an earlier capacity "stepdown" by SoCalGas, that cut El Paso's firm gas deliveries to the biggest U.S. gas utility by 34%.

El Paso last year started negotiations on what to do with stranded investment in capacity turned back to California, a result of overbuilt interstate pipeline capacity to the state. Transwestern Pipeline Co., also a major interstate system serving California, hammered out a similar settlement with its customers over that issue, which FERC approved last year.

The problem of capacity turnback, spawned in the wake of gas industry deregulation, is expected to spread to other states in the next decade (OGJ, Sept. 11, 1995, p. 18).

Settlement basics

Under settlement terms, customers will pay $254.8 million to El Paso for capacity turned back under stepdown options or contract expirations.

That represents about 35% of the net revenue loss assignable to unsubscribed capacity. El Paso will bear the remaining 65%.

In exchange, El Paso's customers will obtain credits totaling 35% of net revenue the pipeline receives for marketing turned back capacity the next 8 years. El Paso will retain the remaining 65%.

The customer credits will be given after the pipeline recovers amounts allocated to interruptible and nontraditional firm service.

The settlement was negotiated between El Paso and about 30 gas distribution companies, municipal utilities, and state agencies in California, Arizona, Nevada, and New Mexico. It incorporates the Jan. 1 SoCalGas stepdown as well as Pacific Gas & Electric's 1.14 bcfd contract termination looming for Jan. 1, 1998.

How it works

In addition to the sharing of turnback losses and revenues from marketing turned back capacity, the settlement:

Provides a rate structure that will remain in place until Jan. 1, 2006.
Permits El Paso to retain the benefit of all cost savings and productivity improvements it is able to achieve through that 10 year period.
Authorizes El Paso to negotiate rates according to market demands, up to a rate cap. To meet competitive needs in a market characterized by excess capacity and changes flowing from deregulation of the electric power industry, El Paso will be able to negotiate rates that assign costs between usage and reservation components in a way that differs from FERC's straight fixed variable rate design, just as shippers marketing released capacity are allowed to do.
Permits annual increases in the base settlement rates to reflect inflation. The settlement rates will increase at about 50% of the annual rate of inflation, subject to a 1% floor and a 4.5% ceiling applied to the base rates.
Includes a cost of service of about $490 million/year, which includes a 15% pretax return and is calculated on a rate base of about $1.2 billion. El Paso had sought a cost of service of $557 million/year.

Benefits

El Paso and SoCalGas cited a number of benefits to be gained from the settlement beyond solving for the long term the problem of capacity turnback, which the pipeline company cited as the most pressing problem it faces.

"The settlement provides El Paso and its customers with the ability for the first time in many years to make long term plans respecting their energy needs based on a secure understanding of El Paso's rate structure," El Paso said.

It also provides El Paso new rate tools that will be needed to operate in the increasingly competitive gas market, the company said.

In addition, El Paso said the settlement ensures that El Paso and the U.S. Southwest gas reserves to which it has access "will continue to play a significant role in the expanding energy markets of the Southwest and West Coast of the U.S. and northern Mexico."

SoCalGas said, "The settlement has the effect of reducing the overall cost of interstate gas capacity coming to California."

The utility cited a new base reservation charge under the settlement that will be implemented this year and increase at only 50% of the rate of inflation during 1998-2005, lower than the current charge in effect since 1992. El Paso's tradeoff here is being allowed to retain all cost savings.

In addition to cutting costs, SoCalGas noted, the settlement:

Significantly increases the allocation to interruptible and nontraditional firm transportation service.
Improves access to capacity from the San Juan basin for existing customers.
Resolves the issue of refunctionalization-whether El Paso system costs are properly allocated between gathering and mainline transmission.

SoCalGas also noted the El Paso settlement meets FERC's expectation that an agreement similar to the Transwestern settlement be worked out in lieu of litigating a rate case.

Under FERC procedures, the parties affected by the settlement have until Apr. 4 to express support or opposition. Opponents of the settlement can litigate in El Paso's pending rate case over what rates they will be, but that won't affect approval and application of the settlement to its proponents.