Energy Policy Update for Gas-Fired Generators

In this issue:

  • FERC Seeks Industry Comments on Possible Changes to Capacity Release Rules
  • FERC Clarifies Criteria for Granting Market-Based Rates for Gas Storage Facilities
  • FERC Adopts Revisions to Blanket Certificate Rules Designed to Expedite Gas Project Development

FERC Seeks Industry Comments on Possible Changes to Capacity Release Rules

On January 3, 2007, the Federal Energy Regulatory Commission (FERC) issued a notice requesting comment on two petitions seeking changes to and clarifications of the capacity release rules. In the first, Pacific Gas & Electric Company and Southwest Gas Corporation (PG&E/Southwest) jointly requested that FERC remove the price cap on capacity release transactions. Under the current rules, shippers who release capacity may not charge a higher rate than the rate they pay to the pipeline. In contrast to this “as billed” rate cap for shipper releases, pipelines have much greater pricing flexibility. They may enter into negotiated rates for sales of capacity based on the “basis differential,” which is the basis spread between two natural gas trading points, such as a supply area receipt point and a market area delivery point. This may result in a rate that exceeds the pipeline’s maximum tariff rate as long as the pipeline also offers a cost-based recourse rate option.

PG&E/Southwest argued that removing the price cap on released capacity would improve the efficiency of gas markets by creating a mechanism that will enable those shippers who value capacity the most to acquire such capacity during periods of constraint. In support, they present market data summarizing the impact of FERC’s 2000-02 temporarily elimination of the price cap under Order No. 637 on gas markets. They contend that this data demonstrates that removal of the capacity release rate cap increases available peak capacity and facilitates the movement of capacity into the hands of those that value it most highly.

PG&E/Southwest’s petition is likely to attract support from large end-users, such as electric generators, because additional release market liquidity would enhance generators’ ability to defray pipeline capacity costs during those periods when market demand for their generation is reduced. At the same time, it is expected that pipelines will oppose this petition because increased market liquidity may reduce customer demand for firm capacity contracts.

In the second petition, a group of large natural gas marketers (Petitioners) requested that FERC clarify the operation of the capacity release rules when shippers are engaged in “portfolio management services,” which they characterize as services where one party agrees to manage the gas supply and delivery arrangements for another party. Prearranged releases of capacity in today’s market, Petitioners note, are typically only one element within larger commercial transactions. Further, the prearranged release of multiple capacity segments as a single integrated package, and/or the prearranged release of capacity bundled with supply, is the most economic and efficient approach to providing transportation services. Petitioners contend that portfolio management services provide significant benefits to gas consumers, and that FERC should apply its rules and policies in a manner that reflects the current realities of the marketplace. They therefore request that FERC find that: (1) prearranged release transactions that involve both gas supply and capacity are not an improper “tying” of released capacity prohibited under FERC Order No. 636; and (2) portfolio management arrangements that include compensation for gas supplies and transaction fees for services rendered do not cause the capacity release rate to exceed the maximum rate cap. This latter request would be rendered moot if the PG&E/Southwest petition was granted and the price cap eliminated.

In its request for public comment on the two petitions, FERC also posed a number of specific questions for parties to address. One line of inquiry by FERC sure to provoke opposition from electric generators is whether current restrictions on the use of tying arrangements for such activities should be relaxed only for a select class of customers -- namely for local distribution companies seeking a marketer to manage their gas acquisition activities. Comments are due by March 12, 2007.

FERC Clarifies Criteria for Granting Market-Based Rates for Gas Storage Facilities

In a November 16, 2006 order on rehearing and clarification, FERC affirmed its June 19, 2006 decision (as reported in the July 2006 issue of “Gas Developments at FERC”) to adopt new pricing rules intended to foster additional gas storage facility development. New storage development is generally viewed by FERC as likely to help reduce future price volatility in gas markets and to provide markets with greater assurance that peak gas demands will be met. FERC’s authority to implement these new pricing rules derives, in part, from Section 312 of the Energy Policy Act of 2005, which amends section 4(f) of the Natural Gas Act (NGA) to permit FERC, in appropriate circumstances, to authorize market-based rates for storage services even where the provider cannot demonstrate it lacks market power, traditionally an essential prerequisite for any FERC market-based rate authorization.

Following issuance of the final rule in June, a number of utility industry trade associations, including the American Gas Association, criticized the rules adopted by FERC as not providing adequate consumer protections. In its most recent order, FERC rejected these criticisms and ratified its prior actions in all significant respects, while providing limited clarification that may serve to narrow the rule’s scope in the future.

With respect to the application of the new pricing rules to existing storage customers, FERC rejected requests to exclude existing contract holders from such new rules, but clarified that where a pipeline customer’s storage contract allows the storage provider to seek to modify the price terms of the contract under the new rules, such a request does not waive the requirement for a showing of lack of market power. In other words, notwithstanding new NGA Section 4(f), a pipeline still has the burden in such circumstances of demonstrating that it lacks significant market power or has mitigated such market power such that market-based rates are just and reasonable. Further, although it rejected requests to exclude expansions of existing facilities from the new rules, FERC clarified that any storage provider seeking market-based rates for expansion facilities must demonstrate that its proposal will not adversely impact existing storage customers. Pursuant to FERC’s order, the storage provider will need to demonstrate: (1) existing customers will not be subject to additional costs, risks or degradation of services; (2) separate accounts for the costs, services, and commitments provided under its NGA Section 4(f) authorizations; and (3) that it provides non-discriminatory terms and conditions of service under an open-access tariff.

FERC Adopts Revisions to Blanket Certificate Rules Designed to Expedite Gas Project Development

On October 19, 2006, FERC issued a final rule adopting a June 16 proposal (as reported in the July 2006 issue of “Gas Developments at FERC”) to expand the scope and scale of construction that pipelines may undertake under blanket certificate authority; and to clarify that under existing FERC policies, natural gas companies may charge lower rates to “foundation shippers” who provide the initial financial support for new projects as opposed to those shippers who subsequently sign on.

Under this rule, which took effect on December 11, 2006, the streamlined blanket certificate review process is expanded to include three new categories of facilities: (1) mainline facilities; (2) certain storage field facility modifications; and (3) facilities that transport gas from LNG and synthetic gas plants. FERC also raised the blanket certificate cost limits for a self-implementing (automatic authorization) project from $8.2 million to $9.6 million, and raised the cost limit for a prior-notice (authorization granted if no one objects during a limited time period) from $22.7 million to $27.4 million. However, as it initially proposed, FERC is requiring that all construction projects involving these three new types of facilities, even if the cost is less than the self-implementing limit of $9.6 million, be subject to the prior-notice procedure in lieu of automatic authorization.

In rejecting requests to permit automatic authorization for either LNG or synthetic gas facilities, FERC takes issue with the Interstate Natural Gas Association of America’s claim that FERC was being “unduly cautious” because “LNG supplies are not new to the natural gas industry and have been flowing into the U.S. grid for a long time now.” FERC states that the pipeline trade association’s view overlooked the difficulties both stakeholders and FERC had encountered in the last several years in attempting to reach consensus on national natural gas quality and interchangeability standards. The prospect of increasing supplies of LNG, FERC notes, raises concerns as to whether “revaporized LNG could contribute to the physical deterioration of existing gas lines and whether the substitution of one gaseous fuel for another in a combustion application could materially change operation safety, efficiency, performance, or air pollution emissions.” In light of this, and in light of FERC’s June 2006 decision not to establish nationwide interchangeability and gas quality standards but rather proceed on a case-by-case basis (as also reported in the July 2006 issue of “Gas Developments at FERC”), a more cautious approach for evaluating such construction was deemed appropriate. FERC also rejected pipeline industry requests to extend blanket certificate authority to include takeaway lateral lines that connect directly to LNG facilities.

Finally, FERC clarified that rate incentives that are not unduly discriminatory can be based on a variety of grounds, including, for example, different elasticities of demand, volumes to be transported, and length of service commitment. Therefore, FERC was merely restating its existing policy when it concluded that project sponsors may charge lower rates to foundation shippers who commit to the new project in advance of other shippers.