The big winner in new U.S. natural gas regulation may be an activity rather than an industry segment.
Federal Energy Regulatory Commission Order 636, adopted Apr. 8, lifts marketing to a new level of importance (OGJ, Apr. 13, p. 32). And it allows-even encourages-companies of all types to join the action.
For producers, the importance of marketing is nothing new.
Most of them have felt growing economic pressure to sell as well as produce gas at least since the special marketing programs of the early 1980s and FERC Order 436 of 1985, which began to broaden nonpipeline company access to pipeline transportation.
MARKETPLACE OVERHAUL
Order 636, however, overhauls the marketplace itself.
It makes federal regulation less important than before and state regulation more so, It shifts costs among types of gas users, which will change the buying patterns of some. And it creates an array of opportunities for companies-whether they're producers, pipelines, or independent marketers-that can match supplies with transportation rights to deliver gas when and where it's needed.
At this point, no one can know exactly how the gas business will work under Order 636-or whether the order will survive legal challenges such as those that bedeviled its predecessors. Much will depend on complex implementation proceedings that FERC hopes to complete by the 1993-94 winter (see chart).
The market nevertheless is set to change in ways that will affect all parts of the gas industry. The inevitability of change became clear in a Dallas conference earlier this month sponsored by the law firm of Jones Day Reavis & Pogue.
What producers must do, one conference speaker said, is decide soon whether to become "aggregators" -packagers of gas supplies and transportation rights-or leave that business to independent marketers and pipelines.
"If producers drift somewhat in their resolve to approach this market, pipelines and local distribution companies (LDCS) will regain the initiative," said Everett S. Gibbs, Arthur Andersen & Co. partner, Houston audit.
Producers won what they sought from Order 636, Gibbs pointed out, especially greater access to pipeline services and a shift to the straight fixed-variable (SFV) pipeline tariff design (OGJ, Apr. 13, p. 32).
"They need to get on with it if they're going to take advantage of it."
LDCS SQUEEZED
Order 636 forces LDCs to make sweeping changes in a process that will force others, including producers, to change as well.
The new rule squeezes LDCs between an intensified service obligation and the likelihood of rising costs for transportation service.
The once-extensive service obligation of interstate pipelines now exists only to the extent of contracts with gas shippers. Order 636 provides "pregranted abandonment" of contracts for most pipeline services as they expire.
LDCS, governed by state utility commissions, retain service obligations to their predominantly residential and commercial customers but lose the benefits of continuous service obligations of pipelines.
As Brad Keithley, a Jones Day partner, explained at the conference, "LDCs no longer can look to pipelines as the ultimate backup."
LDCs will have to decide whether to continue relying on pipelines, buy gas supplies and transportation service through independent marketers, or buy gas directly from producers and transportation service from pipelines.
Because those decisions will affect LDC service reliability, they will create a new area of oversight for state utility regulators.
At the same time, the change to SFV tariffs will shift some costs to gas buyers whose average demand varies greatly from peak demand-mainly the temperature-sensitive residential and commercial customers of LDCS. Also, LDCs will pay most of the transition costs that Order 636 allows pipelines to recover.
State commissions will resist rate increases associated with the cost shift and transition cost recovery.
As LDCs turn to the market for the gas volumes and transportation they need to fulfill service obligations, therefore, they also will be under growing regulatory pressure to restrain costs, perhaps even to make money to offset new costs resulting from the tariff design change.
LDCs thus may feel forced into the role-new for many of them-of direct purchasers of gas from producers and of transportation service from pipelines.
They will be tough negotiators. As several speakers at the Jones Day conference pointed out, producers seeking to make direct sales to LDCs will be negotiating not only with their prospective purchasers but also with newly aggressive state utility regulators.
TRANSPORTATION COMPETITION
At least some LDCs thus will join independent marketers, pipelines, and producers in competition for transportation capacity that Order 636 promotes.
In general, the order makes pipelines separate transportation from now-deregulated sales service as dose to the producing area as possible. It requires that they offer transportation service equal in quality to anyone who wants it and that they allow market centers and pooling points to develop.
Pipelines also must provide nondiscriminatory access to upstream pipeline capacity and make information about services available to all prospective shippers via electronic bulletin boards. They must offer no-notice firm transportation to replace bundled, city-gate sales service, which FERC said contradicted the Natural Gas Act.
Shippers of all types thus will have equal access to an array of services, including firm and interruptible storage and upstream pipeline capacity, from which to tailor transportation packages. A probable outcome is what Keithley called "intrapipe competition" between holders of firm transportation capacity on a pipeline and the pipeline itself as it tries to sell interruptible service.
Competition for transportation capacity will begin soon under restructuring proceedings established by the order.
The proceedings include a capacity reallocation program under which shippers can release firm transportation rights for sale to others. Pipelines will administer the capacity release programs and can collect fees for the service.
The order encourages further trading of transportation capacity after the restructuring proceedings are complete. A key question, said Kevin P. Madden, director of FERC's office of pipeline and producer regulation, is how much interruptible transportation becomes available and at what price.
Arthur Andersen's Gibbs expressed concern about the middleman role pipelines must play in the capacity reallocation program. Requirements that pipelines post bids for capacity on electronic bulletin boards and that original bidders be allowed to match competing bids may prove too cumbersome, he said.
Beyond that, FERC has left much to negotiation during the restructuring proceedings. The flexibility worries some observers.
"This is a broad, amorphous, vague concept," Paul T. Ruxin, a Jones Day partner in Cleveland, told the conference. "It isn't a rule. It doesn't tell anybody how to do anything."
FAST WORK
FERC expects fast work in the implementation of Order 636.
It will handle restructuring proceedings pipeline by pipeline and has assigned case numbers to each of the pipelines it regulates, dividing them into four groups. Its deadlines provide relatively little time for pipelines and shippers to work out new relationships.
Main issues during individual proceedings, Keithley said, will be terms and conditions of storage service and no-notice transportation, sites of unbundling points and market centers, the extent to which pipeline customers release capacity, procedures for capacity releasing, and rates.
The opportunity for pipeline customers to release their firm transportation holdings probably will require another round of contract negotiations between pipelines and producers.
In fact, the entire order will place new emphasis on contracts.
"We're probably moving toward more long term contractual commitments," Gibbs said. "Whether that means price commitments remains to be seen."
It also remains to be seen whether the order raises or lowers prices at the wellhead. By shifting costs away from power generation and industrial customers under SFV ratemaking, the order should boost gas demand in its main growth markets.
But after the market has assigned costs to all new items on the transportation menu, producer netbacks may suffer.
What's more, legal challenges may ambush Order 636 despite FERC's efforts to let the market and contract negotiations finish the job of restructuring the gas industry.
Ruxin, for one, challenged FERC's claim that Order 636 is the last step in the process and cited major decisions and adjustments the agency left to the restructuring proceedings.
The Jones Day partner voiced concern about the ability of LDCs to meet service obligations. "If pipelines no longer have the duty to serve, if producers no longer have the duty to serve, how long will the LDCs be able to meet their obligations?"
For that and other reasons he expects "a flood of interventions" during restructuring proceedings, including actions by companies unaccustomed to FERC procedures.
Ruxin said Order 636 may be open to legal challenge because of FERC's prohibition of bundled, city-gate firm sales service
"What has happened here is inconsistent with the Natural Gas Act," he said.
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
