The Federal Energy Regulatory Commission plans to complete its campaign to restructure the U.S. natural gas industry with two key rulemakings in the next few months.
The agency has been working on a proposed rulemaking to change pipeline service obligations and complete the transition to a fully competitive gas pipeline system. That rule has been dubbed the "mega-NOPR" because of its expanse.
And FERC is expected to revise its controversial Order 555 governing construction of pipeline facilities. Pipelines and producers are seeking changes to the regulation.
Bennett Johnston (D-La.), Senate energy committee chairman, noted at a hearing, "These rulemakings are particularly important in view of the emerging federal policy favoring increased use of natural gas."
FERC officials apparently believe neither rule should be delayed by the 90 day moratorium President Bush has declared on new federal regulations that could hinder economic growth. FERC sees the rules as helping competition and growth.
GOALS AND UNCERTAINTIES
Martin Allday, FERC chairman, outlined his agency's goals at a Department of Energy/National Association of State Regulatory Commissioners conference.
He said, "Gas is likely to be the natural choice for many customers in the years to come ... so long as nothing, including unnecessary government regulations, gets in the way of full and fair competition with other fuels.
"That's what the commission's policy these last 8 years has aimed at: clearing needless obstacles out of the way so gas can compete to find its full potential as a natural resource."
Allday cited several unresolved problems in gas regulation:
- Pipelines must be able to compete evenly with others to buy and sell gas, and, conversely, others must be able to compete with pipelines in getting their gas delivered.
- Buyers and sellers need more access to the best market driven deals. One way to do that is by using market centers to prevent Balkanized pipelines.
- Industry has to move to a much more time sensitive market. The market must be able to respond faster to commercially significant factors like weather changes.
Ronald Kuehn, chairman, president, and chief executive officer of Sonat Inc. and president of the Interstate Natural Gas Association of America, testified at Johnston's energy committee hearing on the two rules.
Kuehn said, "Our industry has been harmed by the uncertainty created by an unprecedented blizzard of federal regulations exemplified by these two rulemaking proceedings. As a result, it is very difficult to make sound business decisions on large, multiyear projects.
"This uncertainty has gone to the bottom line. Wall Street downgraded pipeline stocks and bond ratings to the tune of several hundred million dollars in 1991 alone. Security analysts are urging investors to avoid pipeline stocks and go elsewhere.
"The financial community also has taken the unprecedented step of making these concerns known to FERC through comments filed in connection with the mega-NOPR.
"This downgrading, and the resulting close-off of some capital markets, comes at a time when the industry needs substantial new capital if it is to construct facilities to serve new markets.
"One of the greatest uncertainties facing the industry today is the magnitude of the costs pipelines will endure to meet mega-NOPR requirements. Potentially, billions of dollars in costs could result if the final rule does not allow flexibility for pipelines to work out the transition to unbundling of services."
MEGA-NOPR
FERC's mega-NOPR proposes to split gas pipelines' merchant functions into discernible parts with separate fees, allowing cost comparisons.
This "unbundling" would require negotiations between pipelines and their customers and culminate in a tariff filing.
Pipelines could make their own gas sales rather than carry gas for a fee and would be regulated like other entities selling gas.
Long lines could recover transition costs associated with changes needed to comply with the new rule.
Because of the unbundling, FERC would shift to the straight fixed variable rate design, which unloads all fixed costs from the commodity rate.
Most lines have been using the modified fixed variable rate method, which places pipelines' return on equity and associated taxes in the commodity component.
Use of straight fixed variable pleases small producers, who have claimed Canada's use of that method has given a price advantage to imported Canadian gas.
The rule also changes abandonment of service because current rules do not contemplate a separate pipeline sales service or short term firm transportation. It would allow pregranted abandonment for all sales and for transportation contracts of less than a year. Longer term transportation is subject to notice and right of first refusal.
FERC'S GOALS
Allday said, "Pipelines must compete in buying and selling gas with everyone else. That's the comparability issue. Others can compete fairly for gas sales only if they can get the same quality of transportation service the pipeline gives itself.
"Until we establish comparability, we can't give pipelines market based pricing for their gas sales. So the transition to a fully competitive gas market will remain incomplete. That means we're still in the purchased gas adjustment business, 3 year rate reviews, and the regulatory overhead stays higher than it needs to be.
"Even more important, the current regime of regulated pipeline sales and noncomparable transportation hurts development of long term gas markets. Comparability is the key to getting credible long term deals back into the industry."
He said comparability will allow gas consumers to buy gas from many suppliers and receive reliable transportation.
Allday said market centers are another key to competition,
"Market centers are where pipelines come together to let producers attached to many pipelines sell gas to customers attached to many pipelines. Neither side has to deal only with partners connected to the same pipeline.
"That improves competition because it lets many buyers and many sellers deal with each other.
"All too often today, we have a fragmented system, one in which producers and customers find themselves locked onto a single system. They can't get to deals on other systems although the systems physically interconnect. That's inefficient.
"The commission cannot and should not mandate market centers. The potential competitive logic of market centers is powerful enough that they will grow on their own where sufficient commercial dynamics exist.
"But we do have to make sure pipeline tariffs don't inadvertently frustrate their development. That means separate and reasonable rates into and out of market centers, where appropriate. It also means separate and reasonable rates for short hauls needed within market centers, where needed."
Allday predicted mega-NOPR changes would enable industry to make longer term deals without regulatory interference and shorter term deals without long lead times.
"Only a few years ago, gas contracts typically called for 2 year terms at a minimum, and that was an improvement over traditional conditions. Many people feared that long term contracts wouldn't be honored and the market couldn't adjust to short term deals.
"Now the shortest tick of the commercial clock tends to be a month. That's a lot better than 2 years. But in a global economy that sees 24 hr currency markets, improvement is still possible.
"I think that in a few years gas marketers will see more use of weekly and daily trading for gas and transportation capacity. And I think that will be an industry that's better at handling times like December 1989, when it was so bitterly cold throughout the nation. But it will need better automated communications.
"It may sound odd at first that I'm suggesting a future industry that's better at long and short term deals. But that's exactly what I see. The two will complement each other as well."
PIPELINES' CONCERNS
Although pipelines have lingering concerns about the mega-NOPR, at a FERC technical conference last month many of them said unbundling will work if the rule does not interfere with their operational control of their systems.
They also want the option to continue offering bundled services.
Ingaa's Kuehn said, "Mega-NOPR is intended to expand market participation. In doing so, however, continued reliable service must be assured. This is particularly important with regard to pipelines being able to continue to offer a bundled city-gate service, the service on which local distribution companies (LDCS) rely for winter peaks.
"Whether or not pipelines have title to the gas does not matter. What matters is that pipelines have operational control over their systems so that no-notice winter peaking service can be provided."
Kuehn also said, "Flexibility must be built into the rule in order to mitigate transition costs. This means allowing the rule to be tailored to the characteristics of each system and the needs of its customers, rather than implementing a rule on a tight time frame pursuant to rigid rules.
"In addition, it is essential for the fiscal well-being of the industry that pipelines be allowed to recover 100% of their transition costs through a direct billing mechanism."
Mike Baly, American Gas Association president, agreed.
He said, "Pipelines must be allowed to retain no-notice, bundled city gate sales service as one option for customers who want to continue such service. Otherwise, this rule will reduce competition if pipelines are not allowed to offer a sales service to compete with producers and marketers."
He said pipelines should also offer other options, including completely unbundled services and services repackaged to suit the customer's needs.
Baly said, "We are not trying to put a brake on progress. We think it's important to respect the fact that different pipelines and their customers have different needs.
"If mandatory unbundling is to work, significant revisions will be necessary so that pipelines will retain operational control over their systems."
Baly said pipelines should be allowed to recover 100% of their prudently incurred costs relative to the transition to the new regime.
"Pipelines have all the motivation they need to minimize transition costs, and it would be illegal-and entirely unfair-to require LDCs to absorb any of these costs since the costs do not result from any action voluntarily undertaken by local utilities."
PRODUCER SUPPORT
Nicholas Bush, Natural Gas Supply Association president, said, "The mandatory bifurcation of pipeline sales and transportation functions is essential to achieving this aim of increased competition among all sectors of the natural gas industry.
"Similarly crucial is the itemization, or unbundling, of each transportation service so each service is listed with its own discrete tariff. Without enforcement of these two proposals, the mega-NOPR will be meaningless.
"Mega-NOPR will not reduce the reliability of natural gas. Unbundled pipeline services can be provided with no diminishment of service reliability because unbundled pipeline services can be repackaged to provide reliable, no-notice swing service. No-notice service is essentially an accounting and contracting issue rather than an operational issue."
He noted a few large major pipelines have unbundled services, and others estimate unbundling would require only some additional electronic measurement, computer applications, and telemetering. Bush said mega-NOPR should be implemented by the 1993-94 winter at the latest.
Denise Bode, Independent Petroleum Association of America president, said comparability of service between pipeline sales and transportation functions will provide gas consumers greater flexibility in choosing gas suppliers and provide producers with more potential purchasers.
She said, "Transition costs that have caused greatest concern among pipelines have to do with their existing contracts with producers. Some pipelines have said the rule will force them out of the merchant function entirely and leave them liable under take or pay provisions in their producer contracts. This is not true.
"Instead, pipelines, like any other gas supplier, will be permitted to make sales. In fact, once sales are unbundled, the commission proposes to allow pipelines to charge market based rates for their gas. This will place pipelines (like other suppliers) in the position of being able to make money or lose money on gas sales.
"And since I've never known a pipeline to pass up the opportunity to make money, pipelines will almost certainly remain significant gas suppliers. therefore, transition costs related to producer contracts with pipelines should be minimal-if they exist at all."
But she agreed pipelines should be allowed to pass through all such costs.
SUPPLY QUESTION
Bode pointed out that some LDCs and high priority consumers have expressed concern that security of supply may be reduced by the rule. She said concerns about supply security go to the heart of federal regulatory policy and are shared by the commission and all segments of the gas industry.
"However," she said, "IPAA is certain FERC will assure that nothing in its proposal will limit or degrade in any way consumers' access to gas supplies or pipeline transportation capacity.
"Rather, by increasing competition in natural gas markets, FERC's proposal will improve opportunities for consumers to obtain gas at a reasonable cost.
"While it is true that FERC proposes to eliminate pipeline sales service obligations under the Natural Gas Act for unbundled sales upon expiration of contracts, this change will simply require customers to rely on contracts rather than government mandated requirements.
"Since virtually every other commodity in America is bought and sold pursuant to contract rather than government edict, this change should not adversely affect the reliability of supplies.
"In fact, it will likely encourage more orderly and predictable gas markets and long term supply arrangements.
"Therefore, all segments of the gas industry will ultimately benefit from this change."
CONSTRUCTION RULE
Closely linked to mega-NOPR is FERC Order 555.
The commission issued Order 553 last Sept. 20, but producers and pipelines have sought a rehearing. They complain the rule's environmental provisions are too burdensome, and the rule is so inflexible it would slow projects rather than speed them.
The order merges existing rules for optional pipeline certificates with Natural Gas Act Section 7(c) rules governing traditional proposals, giving sponsors of proposed pipelines a menu of construction and rate options.
Under traditional pipeline certificates, FERC determines a project is economically sound and then allows construction and operating costs to be rolled into the pipeline's rate base, allocating those costs among customers for the gas.
For decades, FERC has used the test in its "Kansas Pipe Line & Gas Co. decision," which required findings as to supplies, demand, and the desirability of facilities.
Order 555 reduces the number of construction permits required, creates a negotiated ratemaking procedure that allows pipelines and their customers to negotiate rate terms, and sets procedures for meeting environmental requirements.
The order's most controversial provision creates a framework that requires sponsors to bear the risk of recovering construction costs if the project does not meet traditional criteria in the certification process.
Projects meeting a modified "Kansas standard," which requires them to show they have 10 year contracts for 10017, of t&e daily capacity of proposed facilities, will be allowed to recover all construction costs.
But if a facility fails to meet that standard, its initial rates will be based on minimum throughput conditions allowing full cost recovery only if the facility operates at or near full capacity year round.
ORDER 555 OBJECTIVES
Allday said Order 555 was prompted by the need for a better system to approve pipeline construction.
"The nation can't afford to handicap gas by spending years to get pipelines to serve emerging new markets," he said. "We need to let folks build the right pipelines in the right places at the right time.
"If gas is to compete with other fuels, we need to be able to change the pipeline grid much more rapidly than we have."
He said FERC wanted to reduce the time that regulation takes and find sound ways to let pipelines and their customers allocate risk in building pipelines.
"We must go beyond the time when regulators could size up all the risks and guarantee everybody against them. The world just does not and should not work that way.
"We'll do far better to accept, up front, that risk is inherent in construction and that we need to let folks choose to bear the upside and downside of risk, if they wish.
"We have to let those who bear genuine economic risk have some chance of reward if they make the right decision on the project."
ORDER 555 DRAWBACKS
Almost immediately, Order 555 scuttled a proposed pipeline project off Mississippi (OGJ, Oct. 28, 1991, p. 24).
Five pipeline companies withdrew from a $230 million project which would have moved as much as 1.2 bcfd to market.
Kuehn warned that if the construction rule isn't changed it will affect other projects too because it requires pipelines to hold 10 year firm contracts for 100% of the new capacity.
"In today's market, however, contracts between buyer and sellers of gas are for a much shorter time," he said.
"The high capacity requirements leave no room for market growth. The new standard encourages designing pipelines that ultimately are too small for the target marketplace.
"If the pipeline cannot make the 10 year showing, it is allowed to build the project but is placed at risk for recovery of project costs."
He also said the rule's "onerous and unnecessary" environmental regulations will slow construction.
Kuehn said the pipeline industry has tried to work with FERC on a substitute for the "at risk" policy in traditional Section 7(c) proceedings.
"We propose that the 'at risk' provisions apply only to the optional procedure rather than to all new pipeline construction under Section 7(c). This proposal has broad industry support."
AGA's Baly complained Order 555 entails more detailed filing requirements, less flexible rules governing construction, and rigid rate provisions.
"We question whether the commission intended this strangling effect on construction.
"FERC should provide a meaningful opportunity for parties to apply for either rolled in or incremental 'rate treatment depending on whether all customers benefit or not and should establish general criteria for rolled in rate treatment."
PRODUCERS CRITICAL
Producers agree Order 555 would have a chilling effect on construction.
NGSA wants FERC to:
- Couple the negotiated rate option with provisions on mandatory interconnection.
- Drop the 100% throughput rule.
- Allow rolled in rate treatment with the start of service on a new facility.
- Allow negotiation of reservation fees.
IPAA's Bode said the construction rule generally strikes a reasonable balance between speeding construction and the need to protect rate payers from unnecessary investment. But she proposed some changes, too.
"IPAA believes that instead of drawing distinction between onshore and offshore facilities when formulating an 'at risk' condition, the distinction should be between all field area facilities upstream of the 'market center' and downstream of such pooling points."
And IPAA urged FERC to condition open access certificates on the pipelines providing supply area interconnections.
It said without changes in the rule, producers will be denied new opportunities to sell their gas, and consumers will likewise be denied the opportunity to buy more U.S. gas.
NEW RATE PROCEDURES
Allday said underlying mega-NOPR and Order 555 is the need for new rate procedures.
"We need pipeline rates that promote efficiency, send the right signals for new construction, allow reasonable certainty in long term deals, and promote the use of gas wherever it's the right fuel choice."
Allday noted FERC's Order 436 said rates should ration peak usage and maximize offpeak throughput. "It's never wavered, and nothing in our current work changes that.
"I do think we have seen the need to expand our ideas about how to implement efficient rates. One key point is that while transportation rates must make pipeline use efficient, they must also promote efficiency in the rest of the industry. That's the argument for fixed variable rates."
He said using fixed variable rates does not end the rate design policy statement. Rate design includes capacity resale programs, seasonal rate, and distance sensitive rates.
"Events have overtaken some specifics in the rate design policy statement. But the commitment to efficient rates is as strong as ever, and the scope of concern is even wider than before.
"Five years from now you'll see a flourishing market to resell capacity, operating at short time intervals. You'll see many more seasonal rates. You'll begin to see an unchanged basic commitment from the commission to pursue rates that minimize waste."
THE FUTURE
Bush said the two rules will create a "significantly more competitive and focused environment that signals the start of true open access gas transmission and promise a host of benefits to the industry, the consumer, and the nation. FERC is to be congratulated for helping steer the natural gas industry to this position."
"It will complete a highly desirable movement toward a regulatory environment that mirrors free market competition."
Sen. Malcolm Wallop (R-Wyo.) noted, "It is now nearly 8 years since FERC began the transition to a competitive marketplace in May 1984 with Order 380.
"It is now time for FERC to finish the job.
"Regulatory uncertainty can be just as damaging to an industry as bad regulations. FERC should strive to have neither.
"And in formulating the final mega-NOPR and construction rules, FERC must not overreach and go so far as to substitute its judgments for that of the marketplace. Its role is to establish the rules of the game, not the outcome of the game."
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
